How worried should investors be about the prospect of higher inflation rates, despite currently subdued price pressures?
Financiers in the inflation-is-coming camp aren’t concerned about the immediate future. Their argument is that Congress, the White House and the Federal Reserve have pushed trillions of dollars into the economy to shore up businesses and households during the pandemic. The strategy is right for fighting the recession. However, inflation will kick in with a vengeance when the economic expansion gathers genuine momentum.
The perspective has much history behind it. Still, the fear of a sustained rise in consumer price inflation isn’t universally shared. The skeptics reason that the Fed tried without success during the economic expansion to boost inflation and failed. Among the factors thwarting Fed ambitions were technological and organizational innovations symbolized by Amazon and Walmart.
No one knows what will happen to the price level in coming years. Yet the stakes for the average long-term saver (think retirement savings) are high if inflation does spike for a long period of time. Even relatively small increases in the inflation rate erode the purchasing power of money. One hundred dollars loses about a quarter of its value in 10 years with a 3% annual rate of inflation.
What should those saving for retirement and other long-term purposes do to hedge against the uncertain risk of inflation?
Rather than load up on traditional inflation hedges, such as gold and real estate which don’t always work as well as advertised, review your portfolio to make sure it’s well diversified. Diversification has fallen into disfavor in recent years, but the time-honored technique still works well.
Laurence Siegel, director of research at the CFA Institute Research Foundation, was spot on when it comes to diversification in a March article puncturing several financial myths.
Siegel notes that the S&P 500 sported a total return of 13.4% per year over 2010-19. The major market index outperformed every other asset class in the world.
Yet U.S. Treasury bonds also did well over the same time period, up 4.2% per year. “Diversification is still a good and necessary idea; ignore at your peril,” writes Siegel.
Whether the U.S. suffers through a sustained rise in the inflation rate or not, diversification remains one of the simplest and best strategies for investing in an uncertain future.
Chris Farrell is a senior economics contributor to “Marketplace” and Minnesota Public Radio.