With news that inflation is speeding up faster than it has in more than a decade, investors are on edge.
That’s because when the cost of living goes up, investment returns also need to go higher for people to maintain the same buying power. But they don’t always do that.
As a result, investors are left with less.
“The risk is that if inflation heats up that that could gobble up everything you’re earning,” Christine Benz, director of personal finance at Morningstar, recently said.
Stocks are already reflecting investors’ concerns, as the Dow Jones Industrial Average closed down 681.50 points, or 2%, on Wednesday, and the S&P 500 fell 2.1%.
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While inflation can be a real risk for investors, it’s too soon to panic, said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York.
“Anyone who believes they can see into the future is kidding themselves,” Boneparth said.
Signs of what’s to come are mixed, he said. For example, prices rose quickly in April, but the jobs report for the month was majorly underwhelming. The latter suggests the economy may not be heating up as much as some believe.
“It’s early to make changes,” he said.
Despite the recent drops, the market has been good to investors over the last year.
From January 2020 to the beginning of this month, the S&P 500 has had an annual return of more than 20%, according to Morningstar Direct. A $10,000 investment would have grown to more than $13,000.
And although inflation can eat away at market returns, the damage isn’t as bad you may think.
Between 1900 and 2017, the average annual return on stocks has been around 11%, according to calculations by Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore. After adjusting for inflation, that average annual return is still 8%.
Generally, financial advisors caution against making big changes to your investment strategy based off headlines or any one event.
“For longer-term investors, we suggest staying the course if they can,” said Rob Williams, vice president of financial planning at Charles Schwab.
Doing so pays off.
Over the last 20 or so years, the S&P 500 produced an average annual return of around 6%. But if you missed the best 20 days in the market over that time span because you became convinced you should sell, and then reinvested later, your return would shrivel to 0.1%.
Bouts of market volatility, as uncomfortable as they can be, should be expected, said Allan Roth, founder of financial advisory firm Wealth Logic in Colorado Springs, Colorado.
“Pain is a sign you’re investing well,” Roth said.
