6 ways to prepare your investments for higher inflation in 2016
December 15, 2015
Inflation is running at a 0.9 percent annual pace in 2015, after rising by only 0.7 percent in 2014. Is sub-1 percent inflation the shape of things to come, or is it due to perk up in 2016?
With inflation having been low for a sustained period, it won't take much of an acceleration in price increases to be disruptive. With that in mind, you might want to prepare your finances in case the inflation rate does start to climb.
The case for higher inflation
Besides the fact that inflation has been beating the odds by staying so far below historical norms, here are two specific reasons why price increases might be a little steeper going forward:
1. Oil futures suggest energy is due for a turnaround. The futures chain is a series of prices on commodity futures listed according to when those futures contracts expire. This can give you insight into how the market thinks prices over the next few months will differ from those a few years down the road. Strikingly, oil futures for January of 2017 are trading at prices some 18 percent higher than those for January of 2016.
Of course, futures prices are not always right, but this does suggest that there may be short-term disruptions artificially depressing current prices. The prospect of a meaningful rise in oil prices next year is important given that falling oil prices have been a key factor in keeping inflation low recently.
2. Low unemployment should create wage pressures. The last six years have seen the unemployment rate drop in half, from 10 percent to 5 percent. There are all kinds of caveats that go with the unemployment rate figures - the number of people not participating in the workforce at all, the number of people working part-time rather than full-time, etc. - but the fact remains that the number of jobs has been growing and the unemployment rate has been dropping.
Especially as unemployment gets down around the 5 percent mark, this is bound to lead to some wage pressure - not necessarily robust wage growth, but more growth than in recent years. With inflation having been so near zero, it doesn't take much to move the needle.
6 money moves to make in the face of higher inflation
Faced with the possibility of even moderately higher inflation, there are some sensible financial moves you should make:
1. Reduce bond maturities
Inflation essentially devalues future bond payments, so when inflation rises, bond prices tend to fall. The impact is greatest on bonds with the longest maturity because they would be exposed to inflation for the longest period of time. If the prospect is for steeper price increases, moving from longer to shorter bond maturities is the thing to do.
2. Keep savings liquid
Unlike bonds, certificates of deposit (CDs) are not subject to falling prices, but they do lock you into a specified rate of interest for a set time. That can be a disadvantage when a rising inflation environment is likely to start making higher CD rates available. You may want to keep your short-term savings completely liquid in savings accounts or money market accounts, or at least look for CDs with low early-withdrawal penalties.
3. Ratchet up your stock percentage
Don't make a radical asset allocation move, but with interest rates low and bond prices exposed to higher inflation, moving your stock allocation to the higher end of your usual range might be indicated.
4. Distinguish between inflation winners and losers among stocks
Not all stocks react the same way to inflation. For example, if inflation comes from rising oil prices, oil producers stand to benefit, while transportation companies could be squeezed. This might be a good time to look for specific beneficiaries of inflation to emphasize in your holdings, while perhaps weeding out stocks that are especially exposed to rising prices.
5. Pull the trigger on major purchases
Don't use an economic forecast to justify a spending spree, but if you had already planned on a major purchase next year, you might want to do it earlier in the year rather than later.
6. Lock in your mortgage rate
Low mortgage rates could be one of the first victims of higher inflation. If you could benefit from refinancing, do it now - and be sure to refinance into a fixed rather than adjustable-rate mortgage. If you are in the market to buy, you might want to step up the urgency of your search.
These are all fairly simple things to get done. The problem is, with inflation having flown under the radar for so long, it is easy to overlook the simple things you can do to prepare for inflation.
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