When the economy is in recession and inflation rises, the end result is what is known as stagflation. In simpler terms, this means people can earn less while spending more on basic goods and services. Stagflation is rare, but when it happens, you might wonder what it means for your wallet. Adopting a stagflation investing strategy can make it easier to get through periods of sluggishness in the economy.
A financial advisor could help you create a financial plan that suits your investment needs and goals.
What is stagflation?
Stagflation is a period of economic stagnation associated with high inflation. When the economy stagnates, growth slows and unemployment rises. The demand for goods and services may decrease as income levels fall. That in itself is bad enough, but high inflation makes the problem worse, because people’s incomes don’t go as far since prices are higher.
Recessions and inflation occur more frequently separately than they do together. In the history of the United States there have been two periods of marked stagflation, one in the early 1970s and another between the late 1970s and early 1980s. During this time there were more of a dozen recessions since the Great Depression.
Generally, stagflation is bad for consumers because you make less money and everything costs more. For investors, stagflation usually means lower returns as growth slows. The longer the stagflation lasts, the greater the impact on the future value of your portfolio can be.
What is stagflation investing?
Stagflation investing is essentially a defensive approach to managing an investment portfolio to minimize the risks of rising prices and a shrinking economy. Developing an investment strategy for stagflation means:
Identify investments most likely to be protected against the effects of rising inflation and slowing economic growth
Understand which sectors or investments have the best chance of outperforming during a downturn
Diversify your portfolio to minimize the risk of stagflation-related losses
Another key part of investing for stagflation is understanding that it’s unlikely to last forever. Although your portfolio may be affected in the short term, it is possible to recover if you have a long-term investment strategy in place and stay the course through various market cycles.
Best investments for stagflation
Some investments may fare better than others when the economy is stagnant and inflation is on the rise. Reassessing your portfolio can help you decide which investments to include and which you may want to leave out until stagflation is over.
Here are five common options you might consider for investing in stagflation:
Immovable. Real estate investments tend to have a low correlation to stocks, and people still need housing during an economic downturn. Rental prices generally move with inflation and sometimes exceed it, even when the value of the dollar drops.
Value stocks. Value stocks are stocks that are undervalued by the market. These stocks can be good buys when stock prices are lower due to stagflation. The key is to avoid value traps, that is, stocks that appear undervalued but really aren’t.
Gold and silver. Gold is often used as an inflation hedge since its value tends to rise even if the value of other currencies falls. Although investments in gold and other precious metals do not generate income, they can help offset stock market risk during periods of stagflation.
Goods. Raw materials are the raw materials used to make other products. During stagflation, agriculture and oil commodities, in particular, could be poised to outperform stocks and bonds.
Cryptocurrency. Cryptocurrency is still a mixed bag in terms of risk and reward, but it’s an alternative asset you might consider during stagflation. It is important, however, to consider the level of risk you are willing to take, as the crypto market is very volatile.
You can also think of defensive stocks as a hedge against stagflation. Defensive stocks can provide better protection against slowing economic growth and high prices because they are associated with things that consumers still need to spend money on. So you can shift some of your portfolio into consumer staples or healthcare stocks to limit the impacts of stagflation.
What to Avoid When Investing for Stagflation
Some investments are more susceptible to stagflation and you may want to approach them with caution if you are worried about the direction the economy is heading. Here are three common examples of investments that are likely to deteriorate during stagflation:
Growth stocks. When economic growth slows, growing businesses may react by abandoning their expansion plans. Slower growth can negatively affect the prices of these stocks and the associated returns from these investments.
Obligations. Bonds and bond funds tend to lose some of their shine during stagflation as higher prices erode the purchasing power of the future currency they generate. Foreign bonds can outperform domestic bonds when stagflation sets in.
Cash and cash equivalents. Cash and near-cash investments face the same problem as bonds during periods of stagflation. The returns they generate may not be enough to keep up with rising consumer prices, siphoning off purchasing power.
While these investments aren’t ideal for stagflation, they can still play a role in your portfolio. Rather than removing them altogether, you might consider changing your asset allocation to favor stagflation-friendly investments. Once stagflation begins to ease, you can then reassess your portfolio and reallocate assets as needed to stay aligned with your investment goals.
Other ways to prepare your portfolio for stagflation
Besides rethinking your investments, there are other things to consider if stagflation is on the horizon. For example, it’s important to look at the fees you pay to invest.
If you believe investment returns may fall, it is in your best interest to reduce fees as much as possible. So that could mean switching from more expensive mutual funds to lower-cost exchange-traded funds (ETFs). Or you can transfer your trading account to a brokerage that charges less commission or service fees.
Also consider the overall diversification of your portfolio. Diversification simply means spreading your investment dollars in order to spread the risk. The more diversified you are with different investments, the more you can protect yourself against the worst impacts of stagflation.
Investing in stagflation may not be your typical approach, but it’s important to know how to adapt if it happens. And you can use the strategies learned from stagflation investing to help strengthen your portfolio against future recessionary environments and the longer-term impacts of sustained high inflation.
Consider talking to a financial advisor about the best ways to invest for stagflation. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
When investing for stagflation, remember to consider all of your investments, including those held in a 401(k) or IRA as well as money you’ve invested through a taxable brokerage account. If you don’t already have a brokerage account, you might consider opening one to broaden your investment horizons beyond mutual funds or ETFs. There are a number of online brokerages that offer no-fee stock trading with low initial deposit requirements, making it easy to start trading.
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