Hedging Against Inflation
Inflation is taxation without legislation.
Inflation is on the rise with “Singapore's April core inflation rises to 3.3%, fastest in more than 10 years”. We have to ensure that we have enough money to meet possible higher expenses in the future. Many investors consider cash investments to be a safe investing decision, but with inflation on the rise, cash investments may actually introduce a different type of risk to your portfolio.
Cash investments refer to money market funds, savings accounts, fixed deposits, and to an extent, some structured deposits. The general rule of thumb is to hold enough cash to cover 6 to even 12 months of living expenses and possible emergencies, but beyond that, holding cash can do more harm than good.
Rising inflation means your money is likely losing its purchasing power. Having too much cash in your account increases your shortfall risk — the risk that you won’t meet your goals due to low returns from your cash investments. The only way to keep up with inflation is to hold your cash in investments that have the opportunity to go up more than inflation.
Our investment philosophy focuses on factors that you can control:
Risk
Allocation
Costs
Discipline and Goals.
Your asset allocation should be a balance of diversified stocks, bonds, and other investments that reflect your goals, the returns you desire and the possible losses you can take.
Short-Term Bonds Can Help Offset Inflation
In all our portfolios, we usually include a short-term bond fund which offers more than a money market fund without a lot of risk. The short-term bond fund has a variable maturity of anywhere from 12 months to 5 years that the manager can choose to allocate to. The allocation would depend on which bonds around the world has the highest return relative to our local currency. These funds are designed to offer slightly higher yields than money market funds while maintaining limited price volatility.
Total Market Intermediate Bonds Help To Balance Out Your Porfolio
These funds invests in global bond markets and offers the potential for a reliable stream of income. The funds also hedge against foreign exchange movements which means investors can benefit from the diversification that international bonds provide without the extra volatility associated with foreign exchange rates. Whilst these bonds are riskier than short-term funds, it can give a higher yield and helps to offset equity volatility.
Stocks to Beat Inflation in the Long Run
Stocks are one of the best asset classes which have the ability to give returns above inflation in the long run. The equity funds in our portfolios offer broad exposure to global equity markets and focus primarily on growing wealth. However as it is higher on the risk scale, it is appropriate if paired with a suitable range of bonds or for investors with longer time horizons.
What Are The Returns During Historical Periods of High Inflation?
For insights into whether the asset classes highlighted do provide the returns during past instances of high inflation, refer to the table below. In a wide ranging study which measured the effect of US inflation and global asset classes over a long sample period (1927-2020) the researchers found that the potential of most asset classes to outpace inflation over the long term was high.
Short-term bonds defined as one month treasury bills and five year government notes had positive returns above inflation.
Intermediate bonds defined as long-term government and corporate bonds also had returns above inflation.
More importantly, stocks; whether growth or value also had returns significantly above inflation - with value stocks doing much better in general.
So there is no need to chase or seek investments that purportedly outperform during periods of high inflation or rising rates. Floating rate notes, commodities or high dividend yielding stocks have been recently pitched to investors as a "hedge" against the current market environment. The dataset above shows that you can still invest simply in good traditional asset classes to achieve the returns you desire.
As valued clients, investors and friends we want to put your best interests first. We want you to know that sometimes playing it too safe can be a risk in itself, and that we have other options available to help you to meet your goals. As always, building a strong, diversified portfolio is key to long-term investment success.
If you are worried about how inflation could impact you, or your investments, come and speak to us.
