Outsmarting Inflation: A Guide to Preserving Wealth in Uncertain Times

Over the past four years, we have all felt the squeeze of rising prices – from our grocery bills doubling to skyrocketing interest rates on homes and cars. Insurance premiums and property taxes have also surged dramatically in just the past year, leaving many wondering how to navigate these challenges. Inflation’s impact on investments is a critical topic, particularly for affluent individuals looking to safeguard their portfolios. Let’s explore wealth preservation strategies to combat inflation and protect your financial future.

What is Inflation?

According to the U.S. Bank, “Inflation is when the average cost of goods and services increases over time, which leads to a decrease in your purchasing power.” Put in simpler terms, inflation means your money “buys less” as prices increase. For example, in 2020 a gallon of milk cost around $3, and now milk costs around $4, meaning the same amount of money buys less milk. This demonstrates how inflation erodes the purchasing power of your dollar.

Historical Efforts to Combat Inflation

Over the years, the government has tried to combat inflation. For example, “In 1971, U.S. President Richard Nixon implemented a 90-day freeze on wages and prices to counteract rising inflation. This was initially popular and considered effective, but it could not control prices when, in 1973, inflation skyrocketed to its highest levels since World War II. Despite some intervening factors—such as the end of the Bretton Woods System, poor harvests, an Arab oil embargo, and the complexity of the 1970s price control system—most economists view the 1970s as evidence enough that price controls are an ineffective tool for managing inflation.” (Investopedia)

Inflation Today

In recent years, inflation has surged globally. In 2022, consumer prices grew by almost 9%, a significant increase from the 2% average of previous years. Several factors contribute to inflation, including:

• Increased demand, resulting in supply shortages;
• Higher production costs of raw materials or labor;
• Monetary policy, such as tax cuts or lower interest rates.

Another driver of inflation is consumer expectation, sometimes referred to as “built-in inflation.” When inflation persists, people might believe it will continue indefinitely. Workers might demand higher wages to keep up with the rising cost of living. Companies might then increase the prices they charge consumers, fueling inflation further. (U.S. Bank)

Positive Effects of Inflation

While inflation often presents challenges, it can also have some benefits:

1. Investment Opportunities: Inflation can incentivize businesses to invest in expansion projects, anticipating higher profits from future price increases.
2. Wage Growth: Rising wages to match inflation can boost consumer spending, stimulating the economy.
3. Debt Reduction: Inflation erodes the real value of debt, making it easier for borrowers to repay loans over time.

How Inflation Impacts Investors: Risks and Opportunities

Inflation is a critical factor affecting the real value of investments.  While it poses risks like eroding purchasing power, it also presents unique opportunities for wealth growth.  Understanding how inflation impacts different asset classes can help investors make informed decisions.

Opportunities During Inflation

Affluent investors can benefit from high inflation. However, even wealthy investors must manage their portfolios carefully, diversifying to shield against inflation's negative effects and ensuring their investments keep up with rising prices. Here are three opportunities to consider during periods of high inflation:

1. Real Assets Appreciation: Tangible assets like real estate and commodities tend to rise in value during inflation, offering affluent investors an advantage.
2. Income Growth from Larger Portfolios: Wealthier investors may benefit from dividend- or interest-paying investments that increase in value alongside inflation.
3. Debt Reduction Advantage: Inflation erodes the real value of debt, making it easier for borrowers to repay loans over time.

Risks of Inflation on Investments

You shouldn't be too conservative regarding inflation. Inflation will gradually eat away at your savings like a termite if you're not careful. It's essential to be proactive with your portfolio, even if you feel secure. However, high inflation can negatively affect investors by eroding the real value of their investments. Here are three examples of the risks inflation poses on investments:

• Erosion of Fixed-Income Securities: Fixed-income securities, such as bonds, treasuries, and CDs, lose value during inflation because their interest payments remain constant while prices rise. For example:
  • A one-year bond with a $1,000 face value and a 5% interest rate yields $50 in nominal terms.
  • With a 3% inflation rate, the real return is just 2%, reducing the purchasing power of the investment. (U.S. Bank)
• Reduced Real Returns: Inflation diminishes the purchasing power of investment income. Without portfolio adjustments, investors may experience a negative real rate of return.
• Labor Market Challenges: Even affluent investors face challenges, such as stagnant wage growth and tighter budgets at companies. Employers may favor less costly alternatives, including junior employees or AI, over high-salary professionals. (Forbes)

Top Strategies to Protect Wealth During Inflation in 2025

Continuing to contribute regularly to your portfolio is vital, even in periods of high inflation. This ensures that your portfolio continues to grow, albeit at a potentially slower rate than expected. To stress again, even if you have sufficient funds, it’s important to keep adding to your portfolio. The objective is to enhance and protect your wealth throughout all economic fluctuations and lows.

How to Diversify Your Portfolio for Inflation Protection

One of the most practiced approaches to protect your portfolio is through diversification. Diversification helps reduce market risk by spreading your monies across different asset types. For example, you would hedge against inflation by increasing your exposure in some areas and reducing exposure in others, such as long-term bonds, which typically don't perform as well in times of inflation. Some examples of increasing your exposure in certain areas would be investing in growth or value companies, whether domestic or international.

You also want to maintain a low withdrawal rate during periods of high inflation. It's wise to consider adding more stocks than bonds to your portfolio. Stocks can provide a hedge against inflation, especially when inflation is high. Bonds typically perform worse during high inflationary periods, so it's always a smart idea to rebalance your portfolio during these times.

Needs vs. Wants: Maintaining Financial Health When Prices Rise

Ensure you double-check your budget as inflation rises. Start by eliminating any waste in your budget. Examples of budget waste may include:

• Memberships you no longer use;
• Excessive subscriptions to apps you seldom use;
• Limiting your streaming services;
• Unnecessary insurance.

These are just a few examples of potential waste in your budget. It's important to maintain a reasonable lifestyle. Take perceived needs, for instance. A perceived need is something a person believes they need, even if it isn't a true necessity. We all experience this occasionally; however, during periods of high inflation, it’s essential to manage our finances wisely and avoid overpaying for items or increasing our spending rate for things we may not urgently need.

Conclusion: Navigating Inflation’s Double-Edged Sword

Inflation can erode purchasing power and real investment returns, but it also fosters economic growth and provides opportunities for strategic investors. To protect your wealth, remain proactive, maintain a diversified portfolio, and stay invested during inflationary periods. Doing so lets you weather the storm and emerge with a portfolio poised for long-term success.

Sources

How Does Inflation Affect Investments? | U.S. Bank
How Inflation Benefits The Wealthy And Harms The Working Class
How Do Governments Fight Inflation?

Author: Dominik Pruskowski | Allegheny Financial Group | January 2025

The information included herein was obtained from sources which we believe reliable. The views in this article are being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.

Allegheny Financial Group is an SEC Registered Investment Advisor.