Inflation hurts everyone in one way or another. It is the erosion of your purchasing power. Those on a fixed income, as well as the lower and middle classes, are particularly hard hit as they struggle to make ends meet. Worse, it exacerbates inequality and increases poverty. Inequality and poverty can lead to social and political instability. Globally, governments and central banks take this very seriously, so they will deliberately slow the global economy and risk a recession to wrestle inflation to the ground. Last year, global central banks began aggressively raising interest rates in a coordinated effort to combat inflation. One side effect of this strategy is short-term volatility in stock and bond markets as they adjust to the “new normal.” Keep in mind, history tells us that reliably scarce assets such as stocks, bonds and real estate are excellent at keeping ahead of inflation over time.
Most client conversations these days boil down to two things:
1. Concern regarding the erosion of purchasing power. Eventually, there will be pressure to adjust monthly income and expenses to compensate. Families may contribute less or withdraw more from their portfolio as needed. Up to this point, the effect on clients has been minimal as the majority of people simply modify their behaviour. They are consciously being a bit more careful with each discretionary dollar, in order to maintain contribution discipline and resist the temptation to draw more from their portfolio. Subconsciously, they are employing a substitution strategy. They’re replacing one product or experience with another, at a slightly lower price point, and carrying on with life. We are updating financial plans and watching this development very closely.
2. Volatility in portfolios. Traditionally, the basic building blocks of a portfolio are stocks and bonds. This marriage of convenience exists because both stocks and bonds have positive expected returns over time, and usually behave very differently. We would say they have low correlation. Portfolio volatility was elevated last year as stocks and bonds misbehaved, not only at the same time but, for many, to the same degree. While this is unusual, it’s no reason to panic. I simply remind clients that in a well-diversified, thoughtfully built portfolio, we have changed the definition of risk from permanent loss of capital to volatility. The financial plan informs our discipline and is as important as the portfolio itself. Following the plan and maintaining discipline keeps us invested and allows us to take advantage of volatility by shifting wealth from the impatient to the patient investor.