What Should I Do to Protect My Portfolio From Inflation: Tips for Minnesota Families

Inflation-Proofing Your Portfolio: How to Protect Your Investments from Rising Prices

Inflation has been a hot financial topic the past few years. The prices of everything from automobiles to eggs have been rising at a steady pace.
Starting in 2012, the annual rate of inflation stayed below 3% for nearly a decade before steadily climbing in the spring of 2021, eventually topping 9% a year later.¹ While the inflation rate has now dropped back into the 3% range, this roller-coaster price ride has many Minnesota families wondering how inflation affects their finances.
In this article, we will examine the impact of inflation on your investment portfolios and retirement savings. We’ll also look at how to protect yourself from inflation by exploring strategies that can help shield you from the negative effects of surging prices and preserve your purchasing power in the future.

Inflation is a broad rise over time in the price of goods and services across the economy. This price expansion erodes the purchasing power of individuals and families so that the same amount of money buys less in the future than it does today.

The rate of inflation in the United States is generally gauged using the consumer price index (CPI), which is a measure of the average change over time in the prices paid by consumers for a market basket of goods and services.² For example, if this market basket cost $100 last year but $105 this year, the annual inflation rate would be 5%.

Inflation isn’t necessarily a bad thing — some inflation is necessary for a healthy economy. Deflation, or a general decline in the price of goods and services, can be more damaging and even a threat to economic stability in extreme cases. That’s why the Federal Reserve seeks to maintain a target inflation rate of 2% over the long term.³

It’s fairly easy to see the effects of inflation on everyday spending, like the price of items you buy at the grocery store (such as milk and cereal) or menu prices when you eat at a restaurant. But it can be harder to see how inflation influences your investment portfolio and retirement savings.

Consider a money market savings account, for example. If the savings account is paying 2% interest but the inflation rate is 3%, you’re actually losing 1% on your money each year.

Now consider the long-term impact of inflation on your retirement finances. If you need $45,000 per year today to sustain your current lifestyle, in 30 years you would need $109,000 to have the same buying power if the annual inflation rate were 3% — more than twice as much money. Not factoring this into your retirement planning could lead to a serious cash shortfall after you retire and heighten the risk that you could outlive your retirement savings.

To understand the impact of inflation on investments, we need to differentiate between nominal interest rates and real interest rates:

• The nominal interest rate does not adjust investment returns to account for inflation. The stated interest rate for most investment securities is the nominal rate.
• The real interest rate adjusts returns for inflation. For example, if the interest rate is 4% and the inflation rate is 3%, the real interest rate would be 1%. 

To earn a positive real return, your nominal interest rate must exceed the inflation rate. Otherwise, you’re losing money when you consider the actual purchasing power of your investments.

Let’s look at the impact of annual inflation on a hypothetical $10,000 investment:

Inflation has a different impact on different kinds of investments, including fixed-income investments, equities, and real assets:

Fixed-income investments — Inflation can reduce real returns on fixed-income investments like corporate and municipal bonds, Treasury securities, and certificates of deposit (CDs), which provide a steady stream of income in the form of regular interest payments. 

Here’s why: The interest payments remain the same until the investment matures, which means the purchasing power of the income goes down as inflation goes up. Therefore, the price of bonds falls when inflation is rising. The longer the bond term, the greater the impact of inflation.

Equities — High inflation generally has a negative short-term impact on stocks, so as inflation rises, stock prices tend to fall. This is due to several factors, including lower consumer spending, falling corporate revenue and profits, lower demand for stocks, and potentially higher short-term interest rates. 

Value stocks, or stocks that investors believe are undervalued by the market, tend to outperform growth stocks when inflation is high. On the flip side, growth stocks, or stocks that investors believe will deliver above-average returns in the future, tend to outperform when inflation is low. 

Over the long term, stocks — particularly broad-market ETFs and funds tracking indexes like the S&P 500 — can serve as a hedge against inflation. This is because the monetary value of a stock or stock portfolio can appreciate over time, helping counteract higher overall prices.

Real assets — Assets such as real estate and commodities tend to outperform during periods of rising inflation. The reason being that economic drivers of real assets are often tied (directly or indirectly) to inflationary trends. Real estate prices and rental rates in particular are highly responsive to inflation, so returns are more resilient to rising consumer prices.

For example, property values usually rise along with overall prices due to rising land, labor, and material costs. And property owners can usually raise rents to match higher living costs, which boosts profits and investor distributions. Meanwhile, prices for commodities (such as energy, agricultural products, and precious metals) tend to respond quickly to economic forces that drive the prices of other goods. 

The past few years have demonstrated that inflation can be volatile and unpredictable. While the inflation rate has fallen from the near-historic highs experienced in 2021–2022, it could start rising again in the future with little, if any, warning.

Consequently, some investors are making adjustments to their asset allocations as protection against inflation. Positioning more of your portfolio in inflation-sensitive assets could smooth out real returns over time and lessen the long-term impact of inflation on your funds.

One asset allocation strategy is to increase equity exposure to market segments with higher growth potential, such as small-cap, emerging market, and diversified global stocks. High-yield, floating-rate, and high-quality corporate bonds may also be appropriate inflation hedges for your portfolio. 

Another strategy is to add real estate investment trusts (REITs) to your portfolio. These enable you to reap the benefits of investing in real estate without owning and managing property directly. A REIT is a company that owns and operates income-producing property, such as office buildings, hotels, apartments, warehouses, and shopping centers. Most REIT shares are publicly traded on the major U.S. stock exchanges, which makes it easy for individual investors to invest in commercial real estate.

Gold has traditionally been viewed as a safe haven and one of the best investments for inflation protection. Historically, gold has maintained its purchasing power even during times of rising inflation because it is a tangible asset that tends to hold its value even as central banks are printing more money and further devaluing their currencies. In addition, gold prices typically go up when inflation is rising as investors buy more.

However, gold carries risks you should be aware of before investing. For starters, prices can be highly volatile, meaning it could take years for you to realize a return on your investment. Currently, gold is trading at or near record highs,⁴ so you may run the risk of “buying high.” Gold prices can also be sensitive to political upheaval and changes in government policies, and there are storage and insurance costs if you physically own gold.

Treasury Inflation-Protected Securities (TIPS) may also offer protection against inflation. This is a unique type of Treasury bond issued by the federal government that is indexed to the CPI to protect your savings from inflation. The principal value of TIPS rises along with the inflation rate or falls along with deflation.

TIPS offer maturities of five, 10, and 30 years and pay a fixed interest rate every six months. They can be purchased in $100 increments directly from the federal government through TreasuryDirect or from a bank or broker. At maturity, TIPS return the original or inflation-adjusted principal, whichever is higher. An example illustrates how TIPS work: 

Susan invested $10,000 in a 10-year TIPS bond with a 2% interest (or coupon) rate. If inflation is 3% over the next year, the bond’s face value will increase to $10,300 and the annual interest payment would be $206. Conversely, if inflation were negative over the next year (i.e., deflation) and prices fell by 3%, the bond’s face value will fall to $9,700 and the annual interest payment will be $194. When the TIPS investment matures, Susan will still receive her full $10,000 principal. 

Perhaps the biggest benefit of TIPS is their safety and stability: TIPS are backed by the full faith and credit of the U.S. government, so the default risk is very low. Regular semi-annual interest payments also make them attractive for many investors, especially retirees. In addition, the interest income from TIPS is exempt from state and local taxes (but subject to federal income tax).

There are a few drawbacks to TIPS, starting with their relatively low yield compared to most other types of bonds. Also, the increase in the principal due to inflation is considered taxable income during the year it occurs, even though the income isn’t received until the bond matures or is sold. Finally, TIPS may be illiquid during times of financial crisis or market stress, which could pose a financial hardship if you need to sell the bond quickly.

Inflation could have a big impact on how you withdraw money from your portfolio later, such as in retirement. In a high-inflation environment, you may need to adjust your budget and withdrawal strategies to maintain your standard of living. 

For example, let’s say your budget allows $2,000 per month for groceries, gasoline, car insurance, and utilities, but inflation has increased these costs by 10%. You’ll either need to withdraw an extra $200 per month to cover these expenses or look for ways to cut expenses. 

If you withdraw the extra money, this could jeopardize your portfolio over the long term and increase the risk of outliving your retirement savings. Instead, it might be smarter to tighten your financial belt. For example, you could shop smarter at the grocery store, raise your insurance deductibles, eat out less often, or cut back on entertainment, like going to concerts or movies.

Your health care costs will also probably rise in the future. Medical prices have historically grown faster than overall consumer prices: Between 2000 and 2024, the cost of health care in the U.S. grew by 121% while the cost of all goods and services grew by 86%.⁵ Be sure to factor this into your budget and portfolio withdrawal strategy in retirement, and regularly track your spending to ensure you’re prepared.

Rising prices can have a drastic effect not only on your short-term household finances, but also on your long-term financial planning. Therefore, it’s critical to consider the potential impact of inflation on your overall financial situation, especially during retirement. 

If you have more questions about inflation, Pine Grove is here to help. Schedule a free consultation with one of our wealth advisors today to devise a plan that protects your finances from inflation.

Sources:

¹US Inflation Calculator, “Current US Inflation Rates: 2000-2025”

² U.S. Bureau of Labor Statistics, “Consumer Price Index”

³ Board of Governors of the Federal Reserve System,“Economy at a Glance – Inflation (PCE)”

⁴ World Gold Council, “Gold spot prices”

⁵ Peterson-KFF Health System Tracker, “How does medical inflation compare to inflation in the rest of the economy?”