Capital InsightsFinancial Planning

How Diversification and Smart Planning Can Better Inflation-Proof Your Finances

For the past couple of years, you’d be hard-pressed to go more than a few days without seeing, hearing, or worrying about inflation. While the ups and downs of market cycles, well, cycle in a way that an educated investor may have learned how to weather with aplomb, inflation has a unique way of getting under our skin. It’s the pervasive itch that we struggle to scratch – creeping into your grocery bill, your healthcare, your vacations, and everything in between.

As with any persistent irritant, the desire for relief can become all-consuming – especially because Cost of Living Adjustments (COLA) on salaries or Social Security income typically lag when inflation climbs quickly. Meanwhile, you want a solution that feels like an active response to an urgent problem. What answers can financial advisors recommend to their clients to sooth the burn?

I have terrible news: this post will have no new, exciting suggestions for how to offset inflation. But stick with me for a moment, because I also have great news: you don’t need new or exciting ways to shore up your portfolio against inflation. The steady process of properly diversifying and maintaining your portfolio can build in this protection in advance.

Portfolio diversification

When building a portfolio, a financial advisor makes note of a broad range of factors – considering both details specific to the client (such as risk tolerance, family goals, and time until retirement) and big picture trends in the market (such as the likely stability or volatility of particular investment sectors over time and international influences). For example, we anticipate that individuals who live primarily on fixed income from Social Security or a pension will experience the pinch of inflation more acutely than those still in the workforce or with multiple streams of income.

While you may not be able to pinpoint when interest rates will rise or fall, the fact that they will move at some point in the future is practically assured. An advisor can apply this common foresight in advance of a high-inflation environment to develop a portfolio which includes appropriate breathing room in the withdrawal rate and more conservative investment strategies to cushion the future impact of rising prices when they occur.

An appropriately diversified portfolio will include a range of investments that shine at different points in the economic cycle, according to a client’s needs. An example of this may include large-cap funds to capture the moment when corporate growth is strong, emerging markets for potentially underpriced international exposure, fixed income based in high-quality debt for when inflation is coming back down, and many more.

Strategies for those on a fixed income

But perhaps you find yourself on a fixed income and your portfolio has not been actively managed to incorporate suitable diversification in advance. COLA increases aren’t keeping pace with your surging expenses, and you need a realistic battle plan for what happens now. Here are a few steps you can take to adjust quickly:

Review your cash flow

Take a critical look at your current expenses. When your income is fixed, spending is one important variable that you may be able to change. Are you paying subscriptions for services you rarely use? Do you find yourself tossing expired groceries that were purchased on impulse, rather than with intention? Have you considered options for vacations with lower travel costs, or with access to activities that don’t require expensive additional equipment to enjoy?

Avoid the temptation of debt

If you use credit cards regularly, the costs of inflation may be less visible to you until that statement closing date. While credit cards are useful tools and often necessary in a world that uses less and less physical cash, avoid carrying card balances from month to month. Maintaining your pre-inflation spending habits on the back of high-interest credit creates an ever-deepening hole which you may struggle to free yourself from for years to come, perhaps even long after inflation has calmed.

Create an income stream

Consider whether you have opportunities available to create a new income stream. If your schedule and health permit, taking on a part-time or temporary position may provide you with the additional funds to maintain your current lifestyle without reducing expenses or tapping into debt vehicles. Likewise, if your living situation includes the possibility of renting out an unused portion of your home or finding roommate, both are legitimate options for reducing your overall housing costs.

Protecting against unwelcome economic shifts requires an investment of time and effort in advance, which can be difficult to achieve amid your already busy life. If you have questions or concerns about whether your assets are ready to withstand current and future challenges, connecting with a financial professional may give you the support and reassurance you need to proceed confidently toward your goals.

Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.