INFLATION AND INVESTMENTS
"How does inflation affect my investments?"
Most investors ask this question, particularly retirees who rely on fixed income for their daily living. The impact of inflation depends on the securities in your portfolio. Fortunately, if you invest only in stocks, you need not to worry about inflation - at least for now.
A company’s revenue and earnings should escalate at the same pace as inflation, except in the event of stagflation, which is detrimental to stocks. Stagflation is a condition of slow economic growth and almost high unemployment rate, along with higher prices. The concept is also applicable to companies in the similar situation like a consumer. As it holds more cash, its purchasing power declines with increases in inflation.
However, a firm’s returns may be overstated. In times of high inflation, a company may look like it is progressing, attributing its supposed growth to inflation. When analyzing financial statements, remember that inflation can impact earnings depending on the technique used by a company to evaluate their inventory.
Fixed-income investors are affected the most by inflation. For example, you invested $1,000 in a Treasury bill with a 10% yield last year. Does it follow the 10% return, which is $100 in this example, is real? No. Say the inflation was positive for the year; therefore your purchasing power has declined, and so the real return. To make the explanation more precise, if inflation was 4%, the return is 6%.
The explanations above exhibit the very difference between nominal interest rates and real interest rates. The nominal interest rate is your money’s growth rate, while the real interest rate is the purchasing power’s growth.
While inflation affects investments, there are securities which safeguard your returns against inflation. One is the Treasury inflation-protected securities, a special type of Treasury note or bond. It is similar to any other Treasury. However, the principal and coupon payments are linked to the CPI and increase to recompense for any inflation.
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