With inflation at 9.1% and markets moving into bearish territory in June, investors are worried. Quite frankly, investors today cannot beat 9.1% inflation without taking excessive risk, especially in their fixed income investments.
I recommend that investors get closer to inflation on their fixed income investments to protect their purchasing power. Inflation has been below 2% for almost 10 years. Meanwhile, investors were able to earn a 1.5% 10-year return
When fixed income yields were low, it made sense to compensate for fixed income management by a professional manager by using bond funds. Bond funds have an active manager who can play with the quality of the bonds they buy and experiment with the duration of the bonds to get the desired return, which can be a good decision in the short term, because investors could get a return of nearly 6% in 2020 and 2021. However, long-term bond funds don’t have predictable cash flows, nor do investors know what their investment will be worth when they need the cash.
Ultimately, this inflation will benefit corporate revenue streams by passing higher prices on to consumers, and profits will trickle down to corporate bottom lines. Assuming price ratios remain stable over time, as they always have, stocks should grow as their earnings rise. Therefore, stocks are one of the best long-term hedges against inflation. Similarly, 9.1% inflation is not the norm, and it probably won’t be in the long term.
I recommend that investors assume inflation of 4.6% per year in their financial plans. Initially, this may seem very conservative given the long-term average. However, investors who did now have additional purchasing power thanks to the 10 years when inflation was around 1.5%. Investors also gained more than 28% in the market last year, which also offsets the increase in spending this year. If inflation remains at 9.1% or higher for an extended period, you may consider switching to more conservative and higher inflation assumptions. You should review and update your financial plans at least every two years, allowing you to recalculate the impact of inflation and expenses on your long-term plans.