As one year of uncertainty comes to a close, and another begins, you may have an eye on your investment portfolio for 2022. With inflation rising and talk about interest rates increasing by the end of the year, it's a good time to think about your financial goals, risk tolerance and make investment decisions accordingly.
According to the Bureau of Labor Statistics (BLS), between November 2020 to 2021, the Consumer Price Index (CPI) has risen 6.8 percent – the largest jump since 1982. Energy prices soared 33.3 percent, and food prices increased by 6.1 percent. This is textbook inflation.
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Inflation affects your investment strategy because it limits consumers' purchasing power, impacts the future cash flows of fixed, long-term investments and can impact the valuation of bonds.
On the flip side, as 2021 has shown, real estate performs well during inflation, as property value increases and mortgage payments remain steady. Rental properties profit when housing prices are inflated, as homes get more challenging to buy.
The stock market has a track record for keeping pace with inflation better than some investments if companies are experiencing growth and earning a higher share price. According to Barron's, after inflation volatility peaks, stocks hold well as long as interest rates don't rise abruptly. And, at least for now, interest rates seem to be steady.
In 2021, the Federal Reserve (the Fed) aggressively bought bonds to help fuel the economy and counteract the impact of COVID. This helped drive the stock and housing markets. In early November, the Fed declared its intent to taper those bond purchases to slow inflation. The next step, an interest rate increase, is expected before the end of the year.
When interest rates rise, the cost of investments rises, which slows down the market and lowers the value of commodities and bonds. In short, these fluctuations may impact which asset classes your financial adviser recommends in the coming year.
Consider also: The Effect of Inflation on Stock Prices
2. Diversification and Allocation
At the heart of any sound investment strategy is a balance between risk and return. While higher-risk investments tend to promise higher returns, not everyone has the risk tolerance to chance many high-risk investments. Diversification helps mitigate that risk.
While you may not want to gamble a lot of money, you may allocate a percentage of your funds to high-risk investments to boost investment returns.
Diversification aims for a healthy mix of stocks, bonds and cash investments. Stocks tend to have higher risk and higher returns, while bonds are less volatile with a modest profit. Cash investments, such as money market accounts, certificates of deposit and treasury bills are low-risk, low-return.
You also want a blend of short-term and long-term investments, which may include real estate, retirement accounts, mutual funds and exchange-traded funds (ETFs).
A financial adviser can help create a diversification strategy for you, built according to your investment goals, budget and the period of time you have to invest.
Consider also: Investing in Your 40s
3. The Best Investments Are Researched
Warren Buffett, one of the world's most successful investors, accumulated wealth by researching and evaluating the businesses he invested in. He didn't react based on daily fluctuations of the stock market or upheavals in the world or economy. He advises against treating investments like a casino, favoring instead to invest in a company's history, past performance and bottom line over a long period of time.
This doesn't mean you have to be an expert on researching the price-to-earnings ratio of every company in your mutual fund. But it's good to remember that metrics are part of the picture.
Rather than look at what's hot in the stock market today and invest in a hurry, when planning portfolio diversification with your financial adviser, discuss which companies might be valuable long-term investments to complement the short-term investments in your portfolio.
These principles are part of value investing or finding a higher intrinsic value in a business than the company's stock price. A good beginner's guide to value investing is "The Intelligent Investor: The Definitive Book on Value Investing" by Benjamin Graham, credited with mentoring Warren Buffett.
The pandemic and inflation continue to cause fluctuation and volatility in the economy. Even so, your 2022 investment and retirement plans do not have to be reactionary as much as they have to be mindful. Work with your financial adviser to devise a diversified investment strategy that moves forward on your financial goals with the level of risk tolerance that makes you comfortable.
Consider also: Investing
- U.S. Securities and Exchange Commission: Beginner's Guide to Asset Allocation, Diversification and Rebalancing
- U. S. Department of Labor: Investing and Diversification
- U.S. Bank: Effects of Inflation on Investments
- PBS News Hour: U.S. Consumer Inflation Jumps 6.8 Percent in Past Year
- U.S. Securities and Exchange Commission: Investor Bulletin: Interest Rate Risk
- Bureau of Labor Statistics: Consumer prices up 6.8 percent for year ended November 2021
- Treasury Direct: Treasury Securities & Programs
- Brookings Institute: What Does the Federal Reserve Mean When it Talks About Tapering?
- CNBC: Warren Buffett Archive
- Corporate Finance Institute (CFI): Asset Class