How Inflation and Deflation Affects Your Portfolio

There are many factors that can affect the performance of your investment portfolio. These factors include, but of course are not limited to, inflation and deflation.

Let’s take a look at these two market movements and see how they affect the returns that you can get out of your portfolio.

Inflation

Inflation, as you may have probably guessed from its name, is a market movement that is mostly characterized by a rise in prices. Consider it like the tire of a vehicle – when inflated, the pressure rises and the tire becomes rigid and enhances the stability, for instance, of a motorcycle.

In economic terms, however, inflation is an across-the-board movement in which prices of commodities rise astronomically.

This means one thing – demand for commodities and items will increase, but people’s purchasing power also decreases. The rise in prices causes people to have difficulties in making purchases even though they need to buy the stuff, but there is still considerable demand in the market.

As for companies, they experience reduced revenues, which causes their stock prices, conversely, to fall. You, as an investor, will experience reduced return on your investment in their stocks.

Deflation

Deflation is the opposite of inflation. Whereas prices go up to unprecedented heights in inflation, deflation causes prices to radically drop.

While you may think that this is a good thing because prices are lower than you’ve known them, a closer look will reveal that deflation is a drastic fall in rates. This is because the market experiences a drop in demand, and that has a negative effect in the economy.

Again, this causes a drop in the income of publicly and privately traded companies, but at a rate that’s worse than that in inflation. With the decrease in revenues, companies are forced to close doors and trigger a massive rise in unemployment rates.

Stock prices will fall, as speculative investors are forced to let go of their holdings in anticipation of a further drop in prices.

How To Protect Yourself From Both

As investment gurus always say, diversification is key to hedging yourself from whatever economic problems that may arise in the future. Never put all your eggs in one basket, as they say.

To protect yourself against inflation and deflation, you may want to invest in stocks issued by companies whose target markets will always make purchases no matter what the rise or drop in prices may be. Think of necessities like health care, edible items and personal hygiene, among others.

You could also think about investing in government bonds issued by foreign countries. Theoretically, if you have bond holdings in every country in the hold, your other holdings will hedge you against further losses if one or two companies are experiencing deflation or inflation.

You can also invest in commodities like oil and gold. These are necessary commodities, and their prices tend to be stable or, at the least, increase in demand when all others are experiencing downturns.

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