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How to Prepare for Inflation

Summary

Inflation is all over the news: it’s a scary subject encouraging you to read more headlines. But how should you actually prepare your investment portfolio for potential inflation? As always: it comes down to planning.

If you have a well-diversified portfolio of stocks and bonds then there’s good news: you can do nothing. Be ready to make adjustments as those investments go up or down, as you typically rebalance.  

There are two potential action items below, but first let’s consider:

  • Gold: It’s not a given that gold does well in inflationary environments. I don’t typically recommend gold because its long-term returns are fairly average and well below stock returns.
  • Crypto: Is this the new “store of value” and replacing gold? Not with all the current volatility.
  • Commodities: They typically will rise ahead of inflation, and we’ve seen that over the last 12 months. Will they continue to climb? Unknown.
  • Real Estate: Your home is a great investment during inflation periods because you have a fixed-rate mortgage where dollars are worth less in the future. REITs and rental properties might increase in value or not, depending on increasing rents which are not always guaranteed with inflation

Two areas to consider making changes:

  • Refinance your Mortgage: If you can borrow more or refinance at today’s low interest rates, that could be a good idea when inflation kicks in. The fixed dollars that you pay back 5 years from now will be worth less than they are today.
  • Short-Term Bonds: If rates rise, as is often the case during inflationary periods, then bond prices will fall. Stick with short duration bonds that get reinvested more often

Photo by Krzysztof Hepner on Unsplash

Transcript

Mike: [00:00:00] Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton, charter financial counselor, and financial advisor. Today. I've got an episode with my good friend, Matt Robeson on his on-air radio show where we're talking about inflation. You've heard about it. It's all over the news with scary headlines about inflation is coming.

Is it going to be temporary or long-term and what to do with your investment portfolio? How should you adjust your portfolio, your investments? Given the coming inflation, we discuss all the ins and outs on our radio show today. So I hope you enjoy it. 

Matt: [00:00:40] I'm joined as always by Mike Morton of Morton financial planning. Mike, how are you? 

Mike: [00:00:45] Yeah, good. This morning. A little bit tired. Didn't get enough sleep last night, but otherwise, ready to go. 

 Matt: [00:00:50] We're recording this during the heat wave. You may be hearing this on radio. Not today. You may be hearing this on podcast later on, as we're recording it. It is hot. It is unpleasant.  And, you know, Look, it's very hard to know where the weather will go in the future.

It's also equally hard to know. Where many indicators of health and our economy will go. in the future. One of the. Big topics of discussion in recent weeks has been inflation. Now there's a lot of reasons for that that we could get into right, as the economy comes out of its COVID induced coma.

It's having lots of imbalances in who can hire and who can access their full supply chain. And Yeah.

People are bidding up prices. Anyway, there's all kinds of economics going on here, but for people who are investing for the people, listening at home inflation can have consequences for your personal financial portfolio, your investment strategy.

Let's talk about it. So, Mike what are your current thoughts and expectations when it comes to inflation? 

Mike: [00:01:56] yeah. When it comes to inflation, Matt, I'm not in the prediction business. Cause if I was, that'd be out of business really quickly. I have no idea what's what happened next. And of course I'm concerned about it, but on the other side  we need to be ready no matter what happens. So that's always, my viewpoint is to be ready, no matter which way any of these indicators go in this case, we're talking about inflation.

So I have no idea. If we're going to get a low inflation medium, we're going to have a spike of inflation. If it's going to be. Temporary inflation is going to be long-term inflation. I have no idea, but what I do know is that you need to be prepared for all of those situations, as best as we can, things are gonna happen and we're going to have to adjust, but you should have a portfolio and personal finance situation that is prepared no matter which way inflation ends up going.

And those are some of the things that we can talk about today. 

Matt: [00:02:45] Yeah, I love the way you frame that up because it's exactly why I started a little idly with the comparison to the weather.  If you're banking on a 90 day weather forecast, or what's going to be next year, you might as well play the farmer's Almanac, but you want to be prepared, right?

You want to have your house. Weatherized you want to make sure you have gear for going out and in inclement weather, it sounds like it's the same thing with your investment portfolio. You don't know what's coming. So the idea is for a variety of future scenarios, how do you put yourself in the best de-risked position as you can So how do you do that? How do you prepare or plan for the possibility of inflation or for the possibility of low 

inflation? 

Mike: [00:03:30] Yeah, exactly. I mean, I look back, a year and a half ago, right? I'm in the same kind of question. It's unpredictable. What is going to happen in the markets? Who knew that they were going to be up to the 20%, in 2020. And so did you have a portfolio where you prepared and had a plan and were ready for that scenario?

Again, no matter what happens, so you can read the news and the news is full of. Headlines that get you to read them. So that's why we're reading a lot about inflation and it's all over the place. Cause it's scary. And they want to make you scared. And it's all about reading articles. That's what the news is all about.

But when it comes to your personal finance, have a well-prepared plan, no matter what happens. So in that case, let's talk about last year in the, and the markets, have a sudden dip and then they come back. Did you buy, when things went down, when they were on sale, did you have a portfolio that you just held steady?

Throughout that. So knowing ahead of time, oh, if this happens, then I will do this or I will do nothing is the right way to be prepared so that no matter what comes at you, 

you're 

ready for it.

Matt: [00:04:26] all right. So let's dig in with that. What about when it.

comes to your investments, would you make specific preparations or would you take more of that? I'm going to hold steady type 

approach. 

Mike: [00:04:38] Honestly, Matt, I start with the, do nothing. It's a bizarre way of saying it. Wait, inflation, maybe come in and I should do something.No you should do nothing. If you have a good portfolio, personal finance plan from your budget expenses, retirement plan and education plan, all the nuts and bolts of how you want to proceed over the next one to two years, five years, 20 years towards retirement.

If you have that kind of planned out. Then you do nothing and you just get ready for whatever the markets do next. Okay. So that's always my first take. Now the question is, do you have that, are you well-prepared, what does that mean? So having a good well-diversified portfolio for the future, a mix of stocks and bonds that's appropriate for your level of risk and where you are in life, all those kinds of things.

If you have that in place, you can keep chugging along. Now. Remember, stocks are a good place to be. You'll hear a lot of scary stuff about, oh, maybe get out of stocks. Remember that inflation we're buying products from companies and during inflation, those products go up in price that's inflation.

So those companies are making more money. So therefore your investment in that company is worth more money and your investment in that company should go up. So stocks are always a good place to hedge inflation. All right, now there's other asset classes that we should talk about today and see if they might make sense in your portfolio .

And so those things would be commonly gold comes up all the time, commodities, bonds, and real estate. Those are those are the asset classes that are going to be talked about nonstop. Oh, they're good. Inflation hedges. You should be invested in these different areas. So we should tackle those different areas and see if are they good 

or not?

Matt: [00:06:13] it sounds like there are certain classes of investments that are a little bit of, look, if you get an inflationary tailwind you're putting up a sale and you're going to catch them because they're gonna get propelled along by that trend of price increase. Let me just ask you the other side of it.

Why would we worry? Why is inflation bad? Are there classes of investments or assets where it's going to be a headwind where you're going to be worried about holding 

those 

Mike: [00:06:42] Bonds would be the typical one because in inflationary environments, typically rates are going to go up. Now, obviously we know we have super low rates right now that they can't fall a lot further. So as bond rates go up. Bond prices go down. They work completely opposite. So if you're holding a bond and inflation hits, and the fed decides to start raising rates to try to pull back inflation.

So now we have rising yields, rising interest rates, which is good for savers. If you're saving dollars, you're getting a better interest rate in your checking and savings account. But if you're holding an IOU, a bond for a hundred dollars, That might drop down to $90. So the price of that bond drops. So we need to be more careful in the bond allocation in our portfolio.

And that's the only place that I would have a recommendation for making a change. Matt would be in the bond allocation of a

well-diversified portfolio. 

Matt: [00:07:36] For our listeners, Mike and I actually go back a long way. We attended the same college. We took some of the same undergraduate economics courses. I remember our. Economics, our macro economics professor addressing this question of why is inflation bad? And he used to say it capriciously redistributes income from borrowers to savers.

And that's an explanation that's okay, you haven't explained anything, but you have given me a lot of big words that you are there. I liked your explanation for that. A heck of a lot better bonds. Not so good stocks, maybe a little bit better. All right. You also mentioned commodities. Let's go there for just a second.

Because you teased it and  it does seem like a place that people focus on in an inflationary environment. So what about a typical commodity, 

Mike: [00:08:28] right. so there's different types of commodities. So I'm less, I'm going to separate gold and the gold bugs from other commodities which are natural resources that are used in the production of goods. Okay. Even though gold is still used, obviously so gold is been a, just a traditional inflation hedge, a store of value.

That's why people like it and it's had good returns over the years. But if you look at the historic returns of gold first, they're not definitely tied to inflationary environments. So realize that they don't always go up when inflation goes up. That's not the case. They March a little bit to their own tune, the price of gold.

It's done well in inflationary 

environments and it's done just 

Matt: [00:09:08] huh? Is that a little bit of a 

misperception out there that, that gold is a classic hedge? It sounds like 

maybe not so

much. 

Mike: [00:09:15] not always and not in lock step.  You know, if you're saying, oh, inflation is going to be high for the next three years, let's say you just knew that will gold do very well over the next three years. I'm not sure. So it's not definitely that they're tied in lock step. The other thing is when we talk about other commodities, they're definitely not tied in lock step.

So does gold have a place in your portfolio? Perhaps I don't typically use it. And the reason why is because it doesn't have long-term historic great returns. Okay. So if you look at the returns of gold over the long-term, as compared to stocks, it's much less. And so I'd rather hold stocks in my portfolio.

If I'm going to hold them for 10, 20 years and want to use those, in the future, I'd rather have stocks 

over 

gold.

Matt: [00:09:59] interesting. So it sounds like, unless you're an old-timey prospector, maybe you should nip that gold mania in the bud before it takes over your life. All right. Let's talk about really out there topics that are impenetrable to most minds, including mine. What about. Cryptocurrencies you do hear that kind of thing.

It's Hey, look, if there's inflation going on, what about crypto? It's not really subject to the same kinds of forces in the economy. Is that a good place to park yourself and tilt your investment portfolio to hedge 

against 

inflation? 

Mike: [00:10:36] Right. So one of the comments about cryptocurrencies and Bitcoin is it's the new store of value. What gold has been for the last, 5,000 years now, it's going to be cryptocurrency as a store of value, and that might be true. I have no idea. Okay. Where the prices of these are going in the future.

The problem with that argument, however, is that. Gold. It doesn't go up and down nearly as much as crypto has been going up and down. I mean, The volatility of the cryptocurrencies is massive. We all know that reading the stories it's going up and down and jumping all over the place. And gold doesn't do that nearly as much.

And so as a store of value, especially if you say, oh, look, inflation is going to be high for three, four or five years. I want  get those tailwinds. I don't think cryptocurrency is going to be the place for that. It might go up massively, but I have no idea about that, but in terms of inflationary wins now, I wouldn't say crypto is a place that you want to be parking 

some cash

Matt: [00:11:27] I think we could say one thing with total confidence, which is that if you could reliably predict the future price of cryptocurrencies. You wouldn't be doing your current line of business because you'd be massively wealthy and you'd say, forget about it. No one on earth can predict the future prices of cryptocurrencies or really anything else.

Okay. Anything else on commodities we missed  before we move on to 

other 

topics? 

Mike: [00:11:51] Yeah. I want to, step back to the other commodities, you know, that are used in production copper raw goods, those types of commodities and  they go with inflation because as the price of goods goes up, the price of those production commodities might go up and then the price of goods have to go up because companies have to buy those to put them into their products.

And so you get this kind of inflationary environment because of commodities, but it's usually ahead of time. Usually prices of those commodities are going up first. And then the price of goods has to follow because companies have to buy them and use them. So it's not always the case that once you think, oh, we're in an inflationary environment, those commodity prices might've already gone up.

And you've seen that the last 18 months that the price of commodities has really shot up. And so are they a good place to invest now for a future inflation environment? Again maybe not. I don't use them too often in portfolios again, because there's other places that I'd rather put my money within stocks and bonds and not get into commodities again, March to their own tune.

So they can be good as a diversifier, 

but you have to know what you're doing.

Matt: [00:12:57] Right. And who knows, maybe someone stole a crop report and substituted a fake one and frozen concentrate, orange juice. I saw that in that documentary trading places. Okay. Let's turn to a different topic. You earlier alluded to real estate. Why should you think about real estate in an inflationary, enviornment

Mike: [00:13:15] so real estate, as all prices are going up, real estate goes up. So that's great. So you could own real estate and those prices should get those tailwinds of inflation and everything rises. Cause it's a real good. So that's, what's great about it. Now. There's a few different flavors of real estate, right?

First of all, everybody thinks of their own home. And your own home is one of the best places to have a fixed mortgage during inflation. And the reason why is because 

The dollars are going down in value.  you need more dollars to buy the same amount of goods, right?

And so you are fixed. Mortgage notice the word fixed stays the same. The number of dollars are the same, even though those dollars are worth less in the future. So if you're paying 2000 a month for your mortgage, that 2003, four or five years is worthless, hopefully your salary has gone up so that you can keep up with buying other goods.

And so your home is fixed. Mortgage is one of the best places to have things to have during an inflationary environment. And hopefully your home price goes up as well. Now. Real estate investments are another thing you can invest in rental properties. You can invest in public REITs, real estate investment trusts that have either commercial properties or retail properties.

If you have your own rental properties, you're hoping that rents go up. And  that can be true in inflationary environments. That rents also go up, but it's not necessarily true. Think of the last 12 months, what happened to rent in certain areas they've stayed flat. They've gone down. So if you owned a condo in a downtown area and everybody's leaving.

It doesn't matter if it was an inflationary environment or not, there are other forces involved, so it's not always the best place to be putting investment dollars. And the same is true with REITs that there are other forces at play, not necessarily just 

the inflationary environment. 

Matt: [00:15:05] so let me see if I'm following the logic here. And I don't want to sound like our macro economics professor about this, but when it comes to having a fixed mortgage, you're paying the bank. And so under inflation, it's good for you. Because the money's worth more. So in, in real terms you're paying less and less. 

Mike: [00:15:28] the money is worth less. 

Matt: [00:15:30] The money's worth less. is you're paying less and less over time. And so you alluded earlier to where you could be facing headwinds and you alluded to bonds. So how does one then. Think about dealing with bonds, because it seems like that's the inverse of that situation where you're going to be paid a set amount that's worth less and less as you move into the future.

So what do you do? Do you just drop 

bonds? 

Mike: [00:16:00] First of all, you got the analogy. Exactly. Right? So a mortgage is a reversed bond. You're paying it, someone else has it. And so that's good for you now think back towards when borrowing rates are going to go up potentially, and your rate stays very low and the dollars are worth less and less.

I think. This past year and even right now is a great time to be refinancing, locking in low fixed term rates. So there's something I would definitely look at doing. If you're in a situation where you could borrow more money on your house or that's comfortable, or you can do that. I look at low rate, fixed term long-term mortgages, but depends on your situation now.

So it's a reverse bond. So where do bonds fit in your portfolio to your appointment? If inflation  spikes up and rates yields on bonds, start going up the price of those bonds go down. So if you hold a 30 year treasury bond, That could potentially be worth less if rates go up. So you're losing money on holding that bond because you're getting that fixed coupon and those dollars are worth less and less over time.

So there are two changes that I would look at. One have short-term  duration bonds, short-term bonds, short-term government bonds. These are very short-term, they're hardly paying anything, but that's not the point. The point is you are getting rid of your inflationary risk. And that's really good. I recommend short-term bonds pretty much all the time.

Anyway, the reason why is I'm not looking to make a lot of money on the bond allocation of the portfolio. If I'm looking to take on more risks to try to  get more money in the future, or have that grow, I'll do that on the equity side. So I would say, take 10% more 

risk on equities 

Matt: [00:17:40] are a hedge 

for 

you. 

Mike: [00:17:42] Correct. Bonds are just there to make a little bit of money, but really there to stabilize the portfolio. 

 Other people do it differently, but that's how I tend to do it is just stick with the short term bonds. So if you have longer, medium term, longer term bonds, you can look to shorten the duration of those bonds.

That's the first thing I would look at. The other thing is there are tips, right? And so these are inflation protected. Bonds now the way these work is that  they get less interest rate now, but they add in the inflation. Okay. So if inflation goes up by 1%, you get that extra kicker. All right. So that is built into the price.

So if we get what everybody thinks is going to happen, you'll get, fairly nominal return on those inflation protected bonds. But if inflation is higher than people predict, or it spikes, that's where you can get a little bit of a kicker from having those bonds in your portfolio. So I'd look at that in the bond side of your portfolio, I'd look at both shortening the duration of regular bonds 

and adding inflation, protected bonds. 

Matt: [00:18:44] So just to totally flog our ship analogy to death. You wouldn't say Chuck, the bonds over the side, it's more diversify a little bit, again, we can't predict which direction the wind is going to be blowing. So what you want is a little bit more in your bond allocation, a little bit more. Diversification tore tips and short term bonds.

just to protect yourself in case we do get 

those 

inflationary 

Mike: [00:19:10] That's right. And then again, go back to the, start, have a plan. So the plan is these are there for stability. You're not going to make a lot, and there's not very much return  anywhere in the bond market. So this is for if it's 10% of your portfolio, 20, 30, 40%, whatever it is, be ready to make changes over the next 12 to 24 months and shift a little bit, depending on what actually 

plays out, what actually happens. 

Matt: [00:19:34] Anything else we need to cover here? I mean, This strikes me as a really good run through of, bonds, commodities stocks, frozen concentrate, orange juice. What else haven't we covered? what else should people be thinking 

about 

here? 

Mike: [00:19:45] I think, just go back to the start that if you have a well-diversified low cost index portfolio for your needs, your particular needs, whether you need cash in the next couple of years, whether you're saving for retirement. Make sure you have a plan and you've implemented that plan. Okay. The portfolio I have today makes sense for my needs for the coming years, and then just adjust that every six to 12 months, depending on what actually 

happens.

Matt: [00:20:13] got it. And do you see your clients coming to you right now and saying, gosh, I'm reading an awful lot about inflation. What do I do? Is this,  something that is on people's minds in real 

time? 

Right 

now? 

Mike: [00:20:26] Yeah, absolutely. It's on everybody's mind because again, it's in the news, people reading it. So clients are coming in and saying, what should we do? Should we change things? Should we do stuff? And if we have a good plan, no, again, we don't have to change anything. The portfolio is there to do certain things.

I remind them that it's there to grow for their needs and we will make adjustments based on what actually happens. Again, I look back to the beginning of 2020 and who would have predicted what's going to happen in the markets during that year. We had a good plan. We went in and just made adjustments based on what actually happened.

Matt: [00:20:57] If people want to read more about this, cause there's always more resources. What's your website. Just let people know. 

Mike: [00:21:02] mortonfinancialadvice.com. 

Matt: [00:21:04] That is Mike Morton of Morton financial advice  and you can find him at mortonfinancialadvice.com. . Thanks so much for listening and we'll catch you next time. 

Mike: [00:21:13] Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at financialplanningpod@gmail.com. Until next time thanks for tuning in