In this blog post, I want to highlight both the negative and positive aspects of how inflation impacts investments. It’s important to recognize that asset classes are affected differently by inflation.
Stocks and real estate investments typically do well in times of inflation. In the case of stocks, companies that can pass along higher prices to consumers can do well in times of inflation. Assuming that to be the case, a company should be able to grow their revenues and profits at least proportionately to the rate of inflation. Real estate can do well due to the fact it may be more expensive to build a home due to input costs such as lumber, labor, land, and other materials being more costly for a new home to be built. Assuming all else being equal, real estate does well as prospective buyers will try to buy something, sooner than later, due to the anticipation of higher prices on the horizon.
Conversely, assets such as cash and bonds don’t do well in times of inflation. The adage “cash is king” is a poor return on investment in times of inflation. An investor’s purchasing power is diminished with inflation, so generating little to no return on cash investments generates negative real returns. For example, let’s assume 5% inflation and a 0.10% rate of return a bank account provides for a $1,000 deposit. Assuming a time horizon of 4 years, an investor will only have $817.94 in inflation-adjusted dollars by “playing it safe”. That investor lost 18% of their purchasing power due to inflation and low returns.
To summarize, inflation can be a hidden tax in terms of consumers paying more for goods and services. Consumer’s purchasing power can be impacted tremendously even more so over the long run. This can be alleviated over the long run by investing in assets that outperform inflation.