Three portfolio steps to take while you wait for inflation to fall

Without a doubt, US inflation is milder now than it was, say, a year ago. But it’s not quite as mild as the Federal Reserve (the Fed) would like it to be. In fact, in recent months it’s moved further from that mark, heating up instead of cooling. And, of course, that means the Fed – which jacked up interest rates in its battle against inflation – will likely keep those borrowing rates higher for longer.

The situation has reshaped the outlook for markets and that should send you a message: don’t just sit there. When there’s a shift in the economic climate, it’s time to check that you’re doing the right things – or perhaps more importantly, swerving anything harmful.

Three investing steps you can take while you wait for inflation to fall.

1. Revisit your asset allocations.

When inflation softens and interest rates start to fall, that’s when stocks tend to rise. The problem is that the path to lower inflation isn’t perfectly mapped. So, the exact timing of when interest rates might fall remains unclear.

And that’s fine: investing is a long-term pursuit, after all, so portfolio tweaks should be made with the big picture in mind. That said, there are some things you’ll want to be aware of.

For one: you can get more protection from rising interest rates if you own shorter-dated bonds. But if the bond market sees a rally as yields fall (remember: bond prices rise as their yields fall), you’ll have lower capital gains on those than you’d have with longer-dated bonds. A big economic slowdown would create this scenario: causing longer-dated bonds to rally more than shorter ones.

And this is, frankly, how things are supposed to work: bonds generally give your portfolio a diversification benefit – in times of economic stress, they usually move in the opposite direction to stocks.

So holding a mixture of long- and short-duration bonds can be an effective way to support your bottom line from whatever the economy throws up.

The benefits of diversification also apply to other parts of your portfolio, notably stocks. While some sectors typically fare better than others in periods of disinflation, such as healthcare and consumer staples, hunting short-term wins with large chunks of your portfolio can be risky.

If you prefer a more hands-off approach, you might instead want to make sure your investments are diversified across various regions, sectors, and asset classes.

2. Continue to drip-feed your investments.

This might not be the most glittery year for markets The “higher-for-longer” inflation environment, which could persist beyond what some economists predicted even just a couple of months ago, could dampen market gains.

But with the US economy showing itself to be stronger than expected – helped by a remarkably robust job market and consumer spending – it’s got its bright spots too. (Even if that does mean the central bank won’t be in a hurry to cut interest rates). In other words, the big picture here might best be described as mixed. And because of that, the market turbulence we’ve seen lately could well continue to play out for the rest of the year.

And that’s why it makes sense to continue to drip-feed money into the market. Dollar cost averaging – or investing a set amount at regular intervals – is a great way to smooth out any volatility.

3. Adjust your cash holdings.

Cash might not offer the potential for super-high returns, but it’s still a core part of any well-balanced portfolio.

And as the pace of price gains slows, the top savings rates will beat inflation by an even wider margin, which could tempt you to keep your cash holdings on the heavy side. That’s understandable, but over the longer term, it could be regrettable.

UK investment manager Schroders analyzed historical data and found that in periods of three months or less, the likelihood of cash or shares beating inflation is broadly the same. However, when it comes to investment periods of 20 years, the firm found that the likelihood of equities outstripping inflation was 100%, whereas with cash it was about 60%.

There are, of course, good reasons to hold cash. It’s handy for emergencies and short-term purchases and can give you the flexibility to pounce quickly on buying opportunities that arise. But when you’ve got additional savings that you don’t need to touch for five years or more, the stock market usually proves a better horse to back, no matter what the savings rate.

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