It is Easier to Deal with a Recession in your Portfolio

Please refer to our privacy policy for contact information.

Inflation or recession — which do stock investors fear the most?

Since most well-allocated stock investors are also bond investors, the question becomes even more important.

Bonds, which can be a relatively safe haven during the market turmoil associated with a recession, take a beating when inflation becomes a problem.

There are Treasury Inflation Protection bonds that offer some protection against inflation, but they can be expensive when demand exceeds supply as is often the case.

Think of TIPs as insurance policies that investors rush to buy when the river begins spilling out of its banks. The better time to buy them was when the sky was clear and there was no threat of flooding.

Rising Interest Rates

The most common treatment for inflation is for the Fed to raise interest rates. Rising interest rates play havoc with bonds since new bonds pay more interest than older bonds. To compensate for the difference in interest rates, bond prices fall.

Rising energy (oil) prices can fuel inflation by making just about everything more expensive to produce and transport.

Along with food prices, the price of energy can seem to distort the inflation rate. However, economists also calculate the rate of inflation (Consumer Price Index) without food and energy.

When this “core” inflation rate begins moving up, it means that higher prices are spreading throughout the economy.

Don’t Abandon Bonds

Investors shouldn’t abandon their investment plan at the first sign of rising inflation rates, however, they should be aware that balancing their portfolio is the best long-term strategy.

Bonds should remain a portion of almost every portfolio. Safer bonds may not pay as much, but conservative investors will sleep better.

To avoid the pain of inflation, consider a well-diversified bond mutual fund or highly rated corporate bonds. You’ll still take a hit if you want to sell the bonds during a period of rising interest rates, but you will reduce the probability of default.

It is often easier to deal with a slowing economy than inflation, because there are more choices when it comes to equities. Stocks of well-managed companies may slip, but long-term investors shouldn’t worry about short-term price changes.

However, that is no reason to abandon bonds every time inflation rears its ugly head. The overall defense against almost all market and economic ills is a well-balanced portfolio of quality stocks and bonds.