Inflation Is Causing Everything To Cost More. Here’s How Investing Can Gain Back Your Spending Power

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Americans are living through the highest inflation in 40 years, with prices rising 8.3% year-over-year in April. That means it costs more to fill up your car and your shopping cart. But what does it mean for your investments?

By investing your money in the stock market, you are attempting to beat the rate of inflation. When you don’t invest, the purchasing power of money in your checking account drops – a dollar buys less gasoline, for example – so your investments should rise to meet the higher prices.

“Ideally, the proposition by the stock market is that if you have your money in the stock market, you’re able to protect your money from losing its value from inflation,” says Daniel Demian, a senior financial advisor at Albert, an automated money management and investing app.

That changes when inflation is higher than expected or comes as a surprise. And with persistently high inflation driven by the supply chain shocks of COVID-19 and Russia’s war in Ukraine, that’s the case now. 

“This is unfortunately a time when you have to wait it out and let the storm pass,” says Liz Young, head of investment strategy at SoFi, an online finance company. 

High inflation can wreak havoc on your spending and investments. Fortunately, experts say investing is a great way to claw back some of that lost spending power. The best strategy is to stick with it for the long haul. 

How Inflation Affects Investment Assets

The main trouble with inflation is that it makes your money lose value over time. Inflation is a normal thing, with the Federal Reserve usually targeting to keep it around 2% every year, but it doesn’t always hit that figure. When inflation is around 8%, like it is now, that means a high return is needed to keep your purchasing power intact. The stock market is a good place to find higher annual returns. The S&P 500, for example, has averaged an annual return of 10% to 11% since its inception in 1926, and about 8% since it adopted 500 stocks in 1957. 

Other assets are also affected by inflation. Some, like commodities and real estate, typically rise as inflation does. A problem with real estate right now is that housing prices have already risen dramatically. “Inflation has already driven those prices up so much, especially real estate, that I actually don’t think this is a good time to buy real estate as an inflation hedge,” Young says.

When investing, it’s important to ensure you have a balanced, diversified portfolio. That starts with broad, low-cost index funds that track major stock market indexes or the whole stock market. “Make sure you’re not overly concentrated in one area but you’re diversified,” Demian says. 

Now can be a good time to get started with investing if you aren’t already. It doesn’t have to be complicated: If you’re putting money away for retirement, make sure you max out your contributions to a 401(k), and if you have one, a Roth IRA, both of which offer tax advantages. A taxable brokerage account is also a way to put money in the market and take advantage of returns if you don’t want to wait until you’re 59 ½. Then you can buy broad, diversified funds, which tend to fare better and with less risk than picking individual stocks. Those can include mutual funds or exchange-traded funds (ETFs) that track indexes of stocks

What Inflation Means for Long-Term Investors

You may not need access to your investments for years or even decades, in which case this inflation and market volatility shouldn’t bother you much at all. Make sure you continue to contribute to your retirement accounts, like your Roth IRA, and put enough into your 401(k) to at least get the employer match.

Panicking can turn temporary dips in your portfolio’s value into irretrievable losses, Young says. Don’t let the volatility of the stock market scare you into something you’ll regret, like selling your investments. Stick with your plan and look at the long term. “If you’re not retiring in the next year, your time horizon is much longer and you can withstand some of the bumps and I would argue you should withstand some of the bumps,” she says. “Over long time periods, the market rises. It never really pays to freak out in the short term, lock in losses, so on and so forth.”

Pro Tip

If you’re not planning on needing your investments for a while, don’t worry about hiccups in the market caused by inflation. Stick to your strategy.

What If I Need the Money Soon?

If you’re nearing the end of your investment horizon, with retirement planned soon, that changes the strategy, Young says. “At that point you’re no longer making money, you’re just spending your money and you’re spending it down,” she says. “That’s when it becomes more important to maintain purchasing power and to have more defensive investments that can protect against inflationary forces.”

There are ways to invest your money in ways that are less susceptible to the volatility that comes with high levels of inflation. One is to invest in mutual funds or ETFs that track less-volatile aspects of the market, often labeled “low volatility” funds, Young says.

Some assets that are designed to guard against inflation, such as Series I Bonds or Treasury Inflation Protected Securities (TIPS) might also be valuable in your portfolio if you’ve got a shorter timeline, Demian says. 

“If you need your money within the next year or two or three, you might want to be more conservative, but if you’re looking at more long-term objectives, then you do have a little bit more capacity to take on risk, especially when it comes to the stock market,” Demian says.