If you’ve ignored the risk of inflation over the past few years, you may need to change your approach. Since the summer of 2016, the headline rate of inflation (including food and energy) has moved steadily upward. In the span of just three months, starting in August, it rose from 0.83% to 1.64%. That trend is expected to continue through the spring, with inflation peaking around 2.4% by the end of Q1 2017. While the final percentages may skew higher or lower depending on a range of factors, it’s clear that inflation will affect the investment landscape. Since rising inflation can erode the real value of assets and income, it’s best to prepare your portfolios to protect against it.
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The above graph shows the headline CPI (consumer price index) and core CPI inflation. It excludes food and energy, which tend to be volatile. Core inflation didn’t fall below 1.5% in the last four years. Low crude oil (USO) prices caused headline inflation to fall in 2014. As oil prices bottomed out in early 2016, inflation started to take off. Headline inflation stood at 2.5% in January, which represents a nearly five-year high.
As the base effect of lower oil prices fades, it could put a cap on inflation in the coming months. That said, proposed aggressive spending by President Trump’s Administration might keep inflation above the 2% mark.
Higher inflation and more rate hikes will require reorganizing portfolios. While equities, like the S&P 500, don’t necessarily underperform during rising inflation scenarios, you could consider diversifying your portfolio to accommodate assets that perform well under such conditions.