Inflation, Inflation, Inflation

Before we get started on today’s topic, it’s day two of Amazon Prime Day. So far I’ve found it underwhelming. I often have most of my Christmas shopping for the kids done and quite a few new electronic toys to play with. I think I find it underwhelming for two reasons:

1. I don’t really need anything new. If I was looking for a computer, cellphone, or wireless earbuds, I would be happy at the savings.
2. The prices aren’t as good. I’m not sure if it’s because Amazon has become so big it doesn’t have to discount as much or if the international chip shortage means that there isn’t room to lower prices as much.

That second point is a perfect transition into today’s topic – inflation. You might have gathered as much from the title, but did you get the reference to the famous Brady Bunch line?

Jane isn’t wrong. Nowadays all anyone wants to talk about is Marcia… er… inflation.

In fact, as I was writing this, I came across this article on CNBC where economist Mark Zandi says, “It could take a year to break even after a 10% to 20% market correction.”

It makes sense. I’ve been seeing inflation everywhere locally. My area of Newport, Rhode Island depends on summer tourism. After missing last year’s season, prices for everything are higher and people are paying them. It might be because people have stimulus money. It might be because they are anxious to get out after a year stuck at home. It might be that the luxury tourism that Newport is known for caters perfectly to the white-collar workers who could keep their income through the pandemic. It’s likely a combination of all three.

I’m also seeing the other side of inflation first-hand. My dog-sitting business is setting new records almost every day. I have so much demand and raising prices doesn’t slow it down at all.

Taking all these signals together, it’s hard for me to come to any other conclusion that inflation is here. That’s typically bad news for your stock portfolio. However, I feel like this time could be different for two reasons:

1. Consumer spending is high. When people spend, companies make profits. Profits are good for stock portfolios.
2. We are starting to wages go up. When people are paid more money, they can spend more money. See #1 on how that leads to more profits. The downside for companies will have more expenses, so this may negate itself.

If you agree that inflation is coming and that it could hurt your portfolio. The natural question to ask, “How can I protect myself?”

Protect Your Portfolio During Inflation

I have to admit that I had to do some research on this one. In 15 years of blogging, I don’t know if I remember a time when inflation might go up. The costs of some things rise, but computers, cell phones, chicken, cell phone plans, and a bunch of other stuff has gotten cheaper it seems.

Here are some ideas to protect your portfolio:

• Hold More Cash – If the market does drop 10-20%, having cash means that you can buy low. When the market recovers, you’ll come out ahead. However, if the market doesn’t drop, you’ll have money that isn’t invested which is a missed opportunity.
• Invest in Financial Companies – Financials will profit because they’ll earn more interest on their holdings. However, I’m reading that they’ll make less on mortgage-lending and stock trading revenues. This may turn out to be a draw. Personally, I’m going to buy a financial ETF (maybe XLF) because I’m underweighted in that category.
• By Gold and Commodities – Gold and commodities tend to go up during inflationary times. However, they’ve both gone up a lot. I don’t like buying things at the top of the market.

You may be tempted to hold more bonds than stocks, but it seems that high inflation hurts both bonds and stocks.

Another alternative is to do nothing. This might be the best overall plan. If it takes a year for stocks to recover to these levels after a drop of 10-20% it won’t be too disastrous for many people. I’m 45 which means I still hopefully have decades of investing left. After how much stocks have gone up over the last 11 years or so, I don’t think taking a one-year pause is necessary a bad thing. If a big drop occurs, I’ll focus more on working for my money than making my money work for me. If I’m part of the inflation cycle by charging more for dog sitting or other freelance work, then the high prices are simply balanced by higher income.

In the end, I’ll likely do a combination of holding more cash (maybe 3-5% of my portfolio) and investing in financial companies. I’m also going to use a couple of psychological tricks. In addition to realizing that I’m invested for the long term, I’m going to look at our overall net worth. By the beginning of this month, it was up more than 15% and it was diversified into real estate and other holdings. If the market drops 20%, our net worth will probably just reset to January.

Easy come, easy go, and a chance to build more assets at a lower price. Got any other ideas, let me know in the comments below.

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