9 Min Read | Published: June 19, 2024
Effects of Inflation on Investments
Learn how inflation impacts investments, including stocks and real assets, and see strategies for mitigating its effects on your portfolio.
This article contains general information and is not intended to provide information that is specific to American Express products and services. Similar products and services offered by different companies will have different features and you should always read about product details before acquiring any financial product.
At-A-Glance
Inflation is a measure of the increase in the price of goods and services over time.
Inflation is a natural part of economic cycles and isn’t generally newsworthy unless levels rise above (or fall below) the forecast.
Investors may take steps to help safeguard their investments in inflationary times, including diversifying with different asset classes, such as equities, real estate, and inflation-protected securities.
When you hear about surging inflation in the news, it may bring up feelings of uncertainty, anxiety, or fear. After all, when inflation is high, it means it’s going to cost more to feed your family, go out to eat, or plan your summer vacation.
Beyond upping the cost of day-to-day goods and services, inflation can also influence your investment portfolio. But just like making smart spending choices can help you manage money responsibly during times of inflation, understanding how inflation might impact your investments can help you make more informed financial decisions.
In this article, we’ll explore how inflation can impact different types of investments and share tips on how to build an inflation-resistant investment portfolio.
What Is Inflation?
Inflation is the increase in the price of goods and services over time. When the news reports on the latest inflation numbers, they’re generally referring to the Consumer Price Index (CPI). The CPI is a tracking mechanism managed by the Bureau of Labor Statistics (BLS) and is a simple way to measure inflation by tracking the cost of buying a basket of goods over time for average urban consumers.1
Have you ever had a grandparent or another loved one say something like, “When I was your age, milk only cost a nickel.” If you have, hold back your eye roll because this is a perfect example of inflation.
Over time, and from generation to generation, the prices of goods and services tend to rise. It’s a natural and expected part of the economic cycle. Inflation typically only becomes a hot-button issue when it’s higher than average.
In times of high inflation, prices rise far more quickly than wages, meaning the everyday American feels the squeeze of paying more at the grocery store, restaurants, and gas station.
Ways Inflation Impacts the Economy
Inflation impacts the economy in many ways, such as:
- Reduced Purchasing Power
As inflation rises, the purchasing power of the average person drops. Let’s say you go to the store with $20 to pick up a few groceries for a nice Italian dinner. You used to be able to buy pasta, sauce, meat, and cheese for $20. But if the cost of each item increases at 10% inflation, it will now cost you $22 for the same meal. That means your $20 has less purchasing power than it used to. If your job hasn’t given you a 10% raise during that same period, you’ll likely feel the pain of now having to spend more to buy the same items.
Did you know?
The Bureau of Labor Statistics (BLS) has an inflation calculator that shows exactly how much purchasing power has changed over time. For example, if you spent $1,000 for a vacation in January 2010, you’d need $1,441.40 to take that same trip in March 2024.2
- Less Savings
If the money in your savings account is not generating interest income that matches or exceeds inflation, your savings are not worth as much. Since many traditional savings accounts pay less than a percent annual percentage yield (APY), any inflation over 1% would mean the money in savings is worth less.3
Impact of Inflation on Investments
While conversations about inflation tend to revolve around how much more expensive things are at the grocery store, there are often far more profound impacts on your investment portfolio. Since your investments typically hold a lot of money (thousands or tens of thousands of dollars compared to the hundreds you spend on goods monthly), fluctuations in the markets due to inflation can have more significant impacts compared to the extra you pay for milk.
If your investments aren’t earning at least the rate of inflation, your future money is going to have less purchasing power. And certain investments tend to fare better than others during inflationary times.
- Impact of Inflation on Stocks
Overall, stocks experience more market volatility during times of inflation. However, not all stocks perform the same. Some stocks in specific sectors, like energy, may perform better as those companies can pass rising costs to consumers. In any case, a stock’s real returns are lower during periods of higher inflation. That’s because real returns are the overall return minus inflation. So if a stock is up 10% for the year, but inflation is 3.5%, the real return isn’t 10%, but rather 6.5%.
- Impact of Inflation on Real Assets
Real assets include real estate and commodities (think oil, precious metals, and agriculture). These assets tend to do well during times of inflation because so much of the cost is often passed along to consumers. For example, if the inputs for real estate rise, including land, labor, and materials, it will result in a higher property value that consumers must pay. For this reason, real estate and commodities are sometimes referred to as an inflation hedge.4
- Impact of Inflation on Fixed-Income Investments
A fixed-income investment guarantees a certain interest income for a set period. Examples include certificates of deposit (CDs) and treasury, municipal, or corporate bonds. A fixed-income investment locked in at a low rate may deliver a subpar return during inflation. That’s because the return you agreed to when you purchased the asset has less purchasing power by the time the investment pays out.
Tips to Help Protect Your Portfolio from Inflation
When you invest money, you’re setting it aside for your future self. And whether you’re not planning to touch it for years or decades, you want to ensure it has maximum purchasing power by the time you need to use it. While there’s no foolproof way to protect your portfolio from inflation, these tips may help:
- Diversify Your Assets
Diversification is the process of stabilizing your portfolio by ensuring you have different asset types and classes. For example, let’s say your portfolio consists of a 401(k) plan, and 100% of the money in that plan is invested in your company’s stock. To diversify your portfolio, you might sell some of your company stock to purchase other asset types, like ETFs, bonds, or mutual funds.5 Having an array of assets within your 401(k) helps decrease your investment risk. So, you may be better protected if inflation is a net negative for your company and its stock performance.
- Explore Inflation-Protected Asset Classes
Treasury Inflation-Protected Securities (TIPS) are an investment that matures in 5, 10, or 30 years with a principal that goes up during inflation and down with deflation. The principal of TIPS is adjusted based on the CPI, meaning that at the maturity of the investment, you’ll get the increased price adjusted for inflation or the original price, whichever is greater. Since you can never get less than your original principal amount, this type of investment is considered “protected” from inflation.6
- Consider Geographic Diversification
Spreading your portfolio’s risk across many countries could help hedge against U.S. inflation. If your investment portfolio is 100% in U.S. securities, it’s subject to fluctuations associated with inflation in the U.S. economy. Putting a percentage of your overall portfolio into international stock or bond funds could provide more stability for your investments by spreading the risk across the economies of more nations and regions.
- Look to High-Yield Savings
High-yield savings accounts (HYSA) are a savings option that tends to be more inflation-resistant than a traditional savings account. Though they’re not directly tied to inflation, like some fixed-income investments are, the interest rates of HYSAs tend to rise with the interest rates in the broader economy, which is more likely to happen during inflation.
Did you know?
Cash is the least protected asset in times of inflation since it earns no interest. That doesn’t mean you need to stop cash stuffing as a spending strategy but think twice before you put money under the mattress for long-term storage.
Frequently Asked Questions
There is no way to say for sure whether investing during inflation is good or bad. However, developing a comprehensive investment strategy and sticking to it regardless of economic conditions may be a good option for investors to consider.
Both borrowers and lenders can benefit from inflation. Since prices and interest rates are higher, lenders may see an increased demand for credit, which is beneficial as it means more new customers. Borrowers who took out a mortgage when interest rates were low now benefit from paying the lender with money that’s now worth less than when they originally received the loan.
The Takeaway
Inflation can feel like a scary term, especially when it’s higher than anticipated. Yet there are steps you as an investor can take to protect your money from losing its purchasing power. A financial professional can help you to understand how your existing portfolio might stack up in times of high inflation and make corrections if needed.
1 “Consumer Price Index Summary,” U.S. Bureau of Labor Statistics
2 “CPI Inflation Calculator,” U.S. Bureau of Labor Statistics
3 “What is the average interest rate for savings accounts?,” Bankrate
4 “Are Real Assets Owners Less Averse to Inflation? Evidence from Consumer Sentiments and Inflation Expectations,” Federal Reserve
5 “Asset classes explained,” BlackRock
6 “Treasury Inflation Protected Securities (TIPS),” Treasury Direct
Brooke Joly is a writer on a mission to unravel the mysteries of personal finance and make them accessible to the everyday reader. When she’s not behind the keyboard, you can find her enjoying the outdoors in Charleston, SC.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
Related Articles
How to Calculate Inflation Rates
Here’s an overview of the typical inflation rates economists use to better understand the U.S. economy, why they matter, and how to calculate them.
7 Tips to Manage Your Money During Inflationary Times
During inflation, we all need to be smart with where we put our money. These tips can help you be a smart consumer and investor to reduce the burden of inflation.
Money Market vs Savings Accounts: What You Need to Know
Savings accounts and money market accounts, while different, can each provide a safe and secure way to earn interest and grow your finances, regardless of market conditions.
The material made available for you on this website, Credit Intel, is for informational purposes only and intended for U.S. residents and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.
