Investing During Rising Inflation & Interest Rates

by | Jul 27, 2022 | Research

Both inflation and the Fed’s actions to mitigate it can lead to turbulence in investment markets. Depending on your goals and risk tolerance, this type of market turbulence could be a nerve-wracking time or an exciting one.

Without careful planning, high inflation and the interest rate increases that typically follow could derail your financial plan. However, with the help of an experienced wealth manager, you can understand how markets react to these factors and develop a strategy to withstand or even profit from the volatility they create.

How Inflation and Rising Rates Impact Investments

Before making investing decisions, it is important to understand how inflation and interest rates can impact your portfolio. When businesses must pay more to produce their products, they have two options: raise prices or absorb the higher costs. The former results in lower demand for their products while the latter reduces profitability. Both scenarios can have an adverse effect on the company’s stock price.

The Fed’s primary tool for controlling inflation is interest rates. When the Fed raises rates, borrowing costs for businesses tend to rise as well. These higher costs can erode company profits and their stock prices. In addition, many stocks are valued using a formula that is based on the risk-free rate. When the risk-free interest rate rises, stock valuations typically fall – especially for growth stocks.

Some stock sectors are more heavily impacted by inflation and rising rates than others. For example, bank stocks can see a boost when rates rise because they can earn more revenue from their loans. On the other hand, demand for high-ticket or luxury items that consumers usually finance can see a decline as some consumers forgo these purchases due to higher borrowing costs.

Tailoring Your Investments to Make the Most of Inflation and Rising Rates

Investors can respond to the turbulence created by rising rates in a few ways. The right choice for you will depend on your goals, time horizon, and risk profile.

Minimize Downside Risk

Risk averse investors, and those saving for a short-term investing goal, should work with a financial professional to evaluate the risk to their portfolio when rates and inflation are high. If you fit into this category, your financial advisor should conduct a thorough review of your holdings to determine how each investment could react to high inflation and rising rates.

Once you have a clear understanding of the potential downside risk, your advisor can help you determine the best way to protect your assets. This could include improving your diversification, reallocating some positions away from high-risk asset classes, or keeping additional cash on hand.

Maintain Your Current Strategy

Investors who are saving for a goal in the distant future may benefit from waiting for a downturn to stabilize before making significant changes to their portfolios. On the other hand, those that panic sell in the middle of a downturn often realize losses and lose the opportunity for their shares to appreciate as markets recover. This means investors with distant savings goals may not want to make any drastic changes in response to market turmoil.

Take Advantage of Market Swings

For those with a healthy appetite for risk, market fluctuations can provide opportunities. If you correctly interpret economic signals, and make investing choices based on these predictions, you can profit from market reactions to inflation and rising interest rates. However, very few investors are successful in timing the markets, so be careful with this approach.

When inflation is high, it can be extremely important to know where your money is invested. All sectors and companies are not equally affected by changes in inflation and rising rates. This provides the opportunity to invest in companies and industries that can withstand or even grow during these types of conditions.

It can be difficult to predict how rising interest rates will impact your holdings, so it is best to work with an experienced wealth manager to choose investments that are best suited to the current market.

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With Investing Gameplan™, and a partnership with a fiduciary advisor, you can make the most of a high inflation, rising rate environment. Whether your goals are asset protection, income, or growth, our advisors can create a custom portfolio of individual stocks and low-cost ETFs to help you achieve them. To get started with Investing Gameplan™, contact us today.