Inflation Can Create Losses in an Investor’s Portfolio

Inflation occurs when the general price of the goods and services rise and, as a result of the increase in cost, the purchasing power of money decreases. The obvious consequence, or effect, of this is that inflation makes it more difficult for people to afford the basic necessities of life if their income is not able to keep pace with the inflation rate. This can also create losses in an investor’s portfolio if their investments are not earning at least as much as the rate of inflation.

The rate of inflation is important as it represents the rate at which the real value of an investment is eroded and the loss in spending power over time. Inflation also tells investors exactly how much of a return their investments need to make for them to maintain their standard of living.

For investors, a high inflation rate has historically been considered anything over the 3% to 4% annual range. In the last decade, the United States has experienced historically low interest rates. This can be attributed to the unprecedented intervention by the Federal Reserve and U.S. lawmakers to avoid the collapse of the global economic system in 2007, 2008, and 2009.

Central banks rely on the relationship between inflation and interest rates. If interest rates are low, companies and individuals can borrow money cheaply to launch a business, earn a degree, hire more workers, or buy a new car. In other words, low interest rates encourage spending and investing, which in turn generally stokes inflation.

During periods when the price of goods and services are increasing, the uncertainty caused by the rising inflation may discourage people from investing. This is especially true for people investing in bonds. Inflation is a bond’s worst enemy; it erodes the value of the investment’s return. Investors can protect their purchasing power and investment returns over the long-term by investing in hard assets that generate an income, such as an investment in shipping containers.

When it comes to inflation, whether you have buried your money in the backyard or it is sitting in the safest bank in the world, it is becoming less valuable with the passing of time. With this idea in mind, investors should try to invest in opportunities that can deliver returns that are equal to or greater than inflation.

Build a Well-Constructed, Well-Maintained Investing Portfolio

The investments in your portfolio can be comprised of a wide range of asset classes. They might include stocks, government bonds, corporate bonds, real estate investment trusts (REITs), exchange-traded funds (ETFs), mutual funds, and certificates of deposit. Also, you may want to include hard assets, such as commodities, commercial or residential real estate, and timber.

A well-constructed and well-maintained investment portfolio is vital to your success. This begins with:

  1. determining an asset allocation that best conforms to your personal investment goals, and
  2. your tolerance for risk.

1. Asset Allocation

Establishing an appropriate asset mix is a dynamic process, and it plays an important role in determining your portfolio’s overall risk and return.

To achieve the ideal asset allocation you must determine your individual financial situation and investment goals. Important things to consider are age, how much time you have to grow your investments, as well as amount of capital to invest and future capital needs.

The motivation of asset allocation is to put your money to work in the best possible places, and in doing so, spread your risk across different investments so you won’t be overly exposed to a downturn in one particular sector. Throughout the entire process of allocating assets to your portfolio, it is important that you remember to maintain your appetite diversification above all else.

2. Risk Tolerance

Another factor to consider is your tolerance for risk. You should have a realistic understanding of your ability and willingness to accept large swings in the value of some investments.

Factors that can affect your risk tolerance are:

  • the amount of time you have to invest,
  • your future earning capacity, and
  • the presence of other assets such as a home, pension, inheritance, etc.

Generally speaking, the more risk you can handle, the more aggressive your portfolio will be. This could mean that you devote a greater portion of your portfolio to the risky stock market, and less to bonds and other fixed-income securities. Other the other hand, if you prefer less risk, your portfolio will be more conservative; in order to protect its value.

Building a well-constructed and well-maintained investment portfolio is a complex process. It requires that you constantly analyze your personal financial situation and balancing it against your goals and objectives. Factors that are likely to evolve over time are your financial situation, future needs, and risk tolerance. When these things change, you must adjust your portfolio accordingly.