By Heather Holden PhD,The Afro News Vancouver
Given recent economic conditions and government interventions, it would be a good idea to consider the potential impacts on your long-term investment planning. Now may be a good time to think about your portfolio return above the inflation rate, in real terms, and to prepare for the risk of higher inflation.
Most investors would agree that preserving and even enhancing their purchasing power over time is a desirable goal. Different investments will serve you differently in your ability to clear the inflation hurdle.
Cash in your savings accounts and money market funds will often yield less than the inflation rate, reducing your overall return. While cash reserves are necessary, it may be beneficial to consider high quality short-term bonds for this purpose. The slightly higher returns of bonds and bond funds can help you keep pace with inflation.
Medium and longer-term bonds typically do poorly in periods of higher than expected inflation for two reasons. First, inflation erodes the purchasing power of the interest income you receive from your bonds. Secondly, unexpected increases in inflation typically result in rising interest rates, which lower the price of the bonds you hold (this only matters to you if you think you’ll sell your bonds before they mature).
Inflation-protected bonds are an important exception to the above. These bonds protect investors against unexpected inflation because they promise to pay a real rate of return plus the actual inflation rate. Their special characteristics make them useful for investors who place great importance on preserving purchasing power.
Stocks are generally thought of as good inflation hedges over the long run as companies are able to charge higher prices to offset rising costs. Stock returns, however, may lag inflation, especially over shorter time periods.
The recent decline in stock markets should underscore that equity investing is not for everyone or for every investment need. Matching goals and risk tolerance with the appropriate mix of investments is the key.
Sophisticated investors may address concerns about inflation by investing in commodity funds. The value of these funds fluctuates with the prices of physical goods such as agricultural products, metals and oil.
Some commodity funds invest in companies that produce commodities while other funds invest directly in the underlying commodity. In general, commodity funds may serve the interests of longer-term sophisticated investors, but often represent only a small percentage of their portfolio.
Investing in the midst of Uncertainty
Prudent investment planning suggests constructing a portfolio that will meet your needs and goals over a range of possible scenarios. While it is impossible to know with certainty how damaging inflation will be in your investment future, being prepared for the full range of possibilities, including a period of inflation during your retirement, can make sense.
Heather Holden, PhD, Wealth Advisor, ScotiaMcLeod
650 Georgia St. Suite 1100, Vancouver, BC, V6B 4N9