The Silent Portfolio Killer: Inflation

[Joseph Bramante]

The inflation alarm bells are on high alert, and investors are jittery.

Inflation is unavoidable at this moment, with economists forecasting inflation for 2021. Last week Billionaire' bond king' Jeffrey Gundlach warned inflation could impact stock prices. Investors have reacted by sending the stock and crypto markets on a roller coaster ride.

Inflation is a portfolio killer - threatening both stocks and fixed income assets in a traditional portfolio. Inflation is a stock killer because it sinks stock prices. The Fed typically reacts to inflation by increasing interest rates to cool the economy - by using the ounce of prevention is worth a pound of cure approach.

Higher inflation means higher borrowing costs and input costs (supplies, materials, labor) for businesses. Theoretically, increased costs mean lower expected earnings in the long run, putting downward pressure on a company's stock price.

It usually takes months for the effects of inflation to play out. Still, mainstream investors don't typically wait around for the shoe to drop - sometimes reacting instantly to bad news as the markets have demonstrated in the past weeks.

The typical reaction by investors to inflationary fears and the potential slide in the standard of living because of reduced buying power is to divest themselves of stocks and put their money into savings or some other fixed income asset like CDs, money market accounts, or dividend stocks. The problem with this approach is the eroding power of inflation.

Putting money in a savings account, CD, or money market account that pays no more than 1% annually while inflation rages at 5% or more is an asset killer - eroding your buying capacity by 4% every year.

As for dividend stocks, they're just as vulnerable to market volatility as every other stock, and dividends are not guaranteed. Moreover, companies can reduce dividends at their discretion - even suspending them altogether during hard times.

Inflation will kill the traditional portfolio, but it won't kill every portfolio. How can you protect your portfolio? Invest in assets that leverage inflation.

As consumers prioritize their expenditures less towards luxuries and more towards necessities, investments in tangible assets that revolve around consumers' needs and not wants are what will best insulate a portfolio against the corrosive effects of inflation.

The ideal asset will generate recession-proof income while appreciating in step with inflation. That's why investors seek out commercial real estate during trying times - to generate recession-insulated income while preserving capital through the period of rising prices.

As the Great Recession taught us, there will always be assets that will be in demand - affordable housing being one of these assets. In a downturn and in inflationary times, consumers will downsize from single-family homes to multifamily housing to reduce expenses. Unfortunately, the demand for multifamily housing starting with the Great Recession hasn't let up - with the gap between demand and supply continually expanding since 2008.

Savvy investors anticipated inflation last year with the infusion of trillions of stimulus money into the economy. They prepared by picking up affordable housing assets, which weathered the storm better than most other commercial real estate segments - being one of the few segments that saw increased rents with low vacancies.

Inflation may kill the traditional portfolio, but it won't kill every portfolio.

Portfolios allocated to tangible assets generating cash flow while appreciating rising prices are the ideal hedge against inflation.

Please do not wait for inflation to rear its ugly head. Prepare now by allocating to the right assets.