High Inflation & Rising Interest Rates: How Should Investors Respond? (Part 1)

Is it 2022 or 1982?

Investors' confidence rose last year, as the pandemic and lockdowns seemed to be ending. There was a positive sentiment in the air, even with outbreaks from new COVID variants. But just as many started seeing light at the end of the tunnel, investors began to worry about the twin threats of high inflation and rising interest rates.

The concerns were not unfounded.

Inflation recorded a 6.8% annual rate in November: a 39-year high, according to the Bureau of LaborStatistics. Prices rose on many consumer items such as housing, food, gasoline (up 58% in 2021), and new and used vehicles.

And inflation continued to rise in 2022: The Consumer Price Index rose by 7.9% through February, the quickest pace of annual inflation in 40 years. Rising food and rent costs contributed to the significant spike, according to the Bureau of Labor Statistics, along with an increase in gas prices that should be more prominent in the March inflation report.

In response, the Federal Reserve just raised rates by a quarter-point and indicated it will hike rates six times this year. The last time there was a similar environment was 1982.

So, how should investors respond to these dynamics?

Two Investment Strategies to Consider

Alternatives: After the S&P 500’s 26.9% advance in 2021, the stock market has been volatile this year. One way to protect your portfolio from the market's fluctuations is to consider alternatives. Alternatives, once only available to ultra-rich or professional investors, are more mainstream now and accessible at lower minimum investments.

Many experts say alternatives should be a part of your total asset allocation these days, as interest rates and inflation climb to multi-decade highs — because alternatives tend to lack correlation to the stock market and traditional assets, which help to smooth your portfolio's performance in periods of choppy or declining markets.

Alternative investments, such as private equity or hedge funds, often rely less on broad market trends and more on the strength of each specific investment. As a result, adding alternatives can potentially reduce your portfolio's overall risk. Alternatives can also enhance your portfolio's risk and return profile and boost total return by providing exposure to a broader set of investments and strategies.

The overall market for alternative investments could rise to $14 trillion by 2023, according to a report by Preqin, a data intelligence provider. At Farther, we educate investors and our clients on the potential benefits of incorporating alternatives into their investment mix. If appropriate, we have various vehicles to implement these strategies.

Bond Ladder: Another investment strategy Farther can provide for our clients is managing a bond ladder constructed with municipal bonds or corporate bonds. A popular method when investing in individual bonds is building a ladder or portfolio of bonds with various maturities. Many investors construct bond ladders to create predictable income streams and mitigate some potential risks from rising interest rates. Instead of purchasing bonds that are all maturing in the same year, you create a ladder by buying bonds that mature at staggered future dates.

For example, let’s say you want to invest $500,000 to produce income for about ten years. You can construct a ladder with ten rungs and a bond maturing each year — up to 10 years (10 different maturities and different issuers) with $50,000 in each rung. Each year that the bonds in the rung mature, you can reinvest the proceeds at the prevailing higher interest rates.

Conclusion

As interest rates and inflation continue to rise, investors should look to diversify part of their portfolios into assets not correlated to traditional investments. We want to emphasize that it’s crucial to take steps to protect the value of your investments and find opportunities to benefit from the changing market dynamics. Choosing assets that are appropriate to your risk level, time horizon, and investment goals can be complex. At Farther, we are confident that we can assist you in selecting investments that are appropriate to help you meet your investing objectives.