| Hi Taylor
- How does inflation affect the stock market? I've always wondered
about that and get hesitant to buy stocks because I don't know if
interest rates are about to go up and whether or not that should change
my tactic. - Olan
Hi Olan - This one is a doozy. I've read a lot of studies relating
to inflation and the stock market, and I've heard so many different
theories as to whether inflation is good or bad for investors. I guess
the short answer to your question is that there is no short answer.
However, here are some notable factors that can at least shed a little
light on the issue.
Inflation tends to hurt growth stocks more. Since inflation
drives down the value of the dollar, it typically hurts growing
companies a little more than established businesses. If you own
stock in a small tech company that needs to spend money in order
to grow, a weakened dollar isn't going to help you out. Meanwhile,
when you own value stocks that are slowly ticking up in price, inflation
can actually help you out in some cases. In theory, owning stocks
in the long term is a safeguard against inflation, since you can
expect a good company's revenue to go up along with the inflation
2. There is a sweet spot. Inflation studies, of which there
are plenty, show that the best real returns come when inflation
is sitting between 2-3 percent. This doesn't mean you should buy
in excess when inflation is holding steady, but rather you should
avoid panicking when it goes up or down a little bit. It always
takes a bit for the economy to adjust and get back on track after
a period of high inflation. This also usually leads to more volatility
in the stock market, so it might be worth waiting to see if the
Fed makes a move and then watching the market's reaction.
3. Play it safe when inflation is high. While you might see
someone hit it rich during a time of high inflation, returns are
historically lower during those periods. I don't think you need
to avoid the stock market when the rates go up, but it's probably
not the right time to go hog-wild. Look at trends and keep an eye
out for stocks that seem undervalued, but don't start overcorrecting
and making too many moves when there's increased inflation.
| This is a solid
question, Olan, and I'm glad you're being this thoughtful with your
investing. One of the smartest things an investor can do is research
what the market has done historically. When you have an understanding
of the causes and effects related to past inflation, that will help
with the decisions you make in the future.
© Taylor Kovar
December 7, 2018
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