Current Context:
While we currently face higher inflation, understanding investing strategies in different inflation environments remains valuable. Some countries still experience low inflation, making this discussion relevant for various economic contexts.
Introduction:
Investors have been experiencing varying inflation environments globally. This article will focus on investing strategies in a low-inflation environment, which has been a recent reality in Australia and may still be the case in other countries. A few simple rules can help manage the impact of low inflation on your portfolio.
The Impact of Low Inflation:
Low inflation has its benefits for shoppers, allowing them to buy goods and services at lower prices. However, it may not be good news for all investors, particularly those relying on cash and fixed interest investments for a reasonable income return.
The impact of low inflation on your portfolio will depend on the type of investments you hold. Some investments may benefit from low and falling inflation, while investments in fixed interest (bonds) and cash tend to be hardest hit because they provide lower income returns when inflation is low.
Economic Context:
Generally, weak economic activity tends to result in low inflation as the demand for goods and services falls. As a result, interest rates, which are linked to the level of inflation, also fall when inflation is subdued. The Reserve Bank of Australia has been cutting official interest rates to historically low levels in reaction to subdued inflation, resulting in declining returns from cash investments.
Investment Strategies for Low Inflation:
Investment strategies can be fine-tuned to maximize returns during periods of low inflation and struggling financial markets. Common mistakes can also be avoided. Here are some tips often applied by successful investors:
- Adjust Your Income Return Expectations:
Low inflation globally and in Australia means that retirees relying on cash and term deposits to generate income have seen their returns fall. You may need to accept lower rates in maturing term deposits or consider other investments that are likely to involve higher levels of risk. It is important to assess the trade-off between how much risk you are willing to accept and the likelihood that your portfolio will grow to satisfy your objectives. Keep your risk profile in mind when assessing the acceptable level of risk. - Avoid Overpaying for Yield:
The search for yield has seen higher-yielding securities increase in price, making them less compelling investments from a valuation perspective. Be cautious not to overpay for securities in the chase for competitive yields. - Take Advantage of Low Borrowing Costs:
Low interest rates may be welcome news for those with debt, especially a mortgage. Consider consolidating your debt into a single loan to take advantage of lower interest rates. Also, reconsider your personal budget to determine your ability to make higher payments to potentially reduce the life of your loan. - Don’t Panic:
When world equity markets struggle, investors are often tempted to sell their share investments. Don’t panic; instead, keep in mind your long-term strategy objectives. Now is probably the time to take a close look at your portfolio, particularly speculative investments, but it is not a time to abandon markets altogether. - Reconsider Your Asset Allocation:
Global stock markets often go through periods of volatility, but over the long term, it tends to pay to favor equities over other more defensive asset classes. However, it is worth considering the merits of asset classes like infrastructure, private equity, and even hedge funds. Your exposure to different asset classes depends on your age, tolerance for risk, and savings objectives. - Set Realistic Expectations:
In an environment where inflation is between 2 and 2.5 percent, real returns of around 5 percent are a worthwhile investment. Don’t be disappointed with these returns, as they represent a healthy performance in a low-inflation context.
Conclusion:
While we currently face higher inflation, understanding how to navigate low-inflation environments is still crucial. By adjusting your strategies and maintaining a balanced perspective, you can make informed investment decisions that align with your financial goals.
The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.
