Council Post: Know The Red Flag In Your Portfolio
Travis Forman, Portfolio Manager at Strategic Private Wealth Counsel – Harbourfront Wealth Management.
Not to alarm you, but there may be a red flag in your portfolio. You might have a sound investment plan and be adequately diversified, but how are you protecting your purchasing power? Do you have inflation-fighting assets in your portfolio?
Whether we acknowledge it or not, we are in an era of higher inflation. Just a couple of years ago, inflation was low, and interest rates were at rock bottom. As we know, this has changed significantly since then. While peak inflation of 9.1% in the United States and 8.1% in Canada may no longer be a reality, a swift return to the days of 2% inflation is also unlikely. If you need to hear it from someone other than me, the multinational investment corporation BlackRock agrees. In its 2023 outlook, the firm stated, “we think we are going to be living with inflation … we see it persisting above policy targets in coming years.”
Should myself, BlackRock and countless other economists be correct in predicting our inflation woes are not over, it is time to evaluate how it will affect your purchasing power over the long term. I challenge you to examine your portfolio and see if you have inflation-protecting assets. If not, it is time to see it for what it is: a red flag. A flag that has the potential to derail your financial plan and prevent you from meeting your financial goals down the line.
Inflation-Fighting Assets To Consider
Private credit and private real estate are a few assets that may help fight inflation in your portfolio. These assets fall under the alternative investments category and can offer potential advantages over more conventional assets such as stocks and bonds.
Let’s examine private credit and private real estate in greater depth.
Private credit, often called private debt, refers to a loan or loans not publicly traded but made by either an individual or institutional investor. These loans differ from traditional ones because they are made by investors, not financial institutions such as banks. Private debt can benefit the borrower as the lending terms are more flexible than traditional ones. It can also be a sound investment for the lender as the loan will likely offer a greater yield. From an inflation protection stance, it can provide advantages to the investor.
With private credit, the terms of the loan may link payment to a number of different factors. Private debt often has a variable interest rate, so payment amounts vary over time. If the rate is floating based on current interest rates, the payment on the loan will rise as the central banks increase their overnight lending rates in response to elevated inflation. This means the lender’s income will climb when inflationary forces are strong and the central bank takes action. It is also possible, though, to have a loan tied directly to the inflation rate itself. Either way, the nature of the loan terms means that inflation can influence private debt returns, allowing the asset to outperform during inflationary periods. Selecting this asset class for inclusion in your portfolio can help to boost income and protect your purchasing power over the long term.
Private Real Estate
Ownership in private real estate involves owning investment properties or a stake in investment properties, where the funding takes place through a private offering. This contrasts those real estate funds listed on a public exchange.
There are two ways that the investment can provide a return. The first is through the property value, which tends to climb over the long term. The second is through income, specifically rental income earned from the asset. For example, residential real estate typically has rent linked closely with inflation. This is because leases are usually short-term and increase at renewal. That jump in rent tends to be at the current inflation rate. With the income earned growing in line with inflation, private real estate can be a valuable inflation-fighting option. It can help protect your portfolio’s purchasing power, ensuring your income keeps pace with inflation.
A Quick Note On Risk
Like all alternatives, investing in private credit or private real estate comes with a level of risk. To gain a better understanding of these risks and implement strategies to help minimize them, be sure to consult with a professional investment advisor. Not only can they help you decide how these investments might fit into your current portfolio, but they can also aid in the due diligence process. Due diligence involves thoroughly researching and auditing any potential purchases. The process can be complex and depends on the specific asset, so it is best to turn to a professional with experience who specialization investing in that area.
The erosion of purchasing power is a significant risk that faces all investors, threatening to set you back from realizing your financial goals. Failing to include inflation fighters in your portfolio is a major red flag and can leave you vulnerable, especially as we shift to an era of elevated inflation.
Of course, I am not suggesting you sell your other positions and move solely into a portfolio of alternative investments. Instead, consider rebalancing and adding an allocation of private assets in your portfolio to help diversify and counter the effects of elevated inflation.
When rebalancing, consider private credit and private real estate, as they have the potential to hedge against inflation. Private credit offers steady income linked closely to inflation itself or interest rates, which tend to rise in an inflationary environment. Private real estate can be a source of rental income likely to increase along with inflation. By including these inflation-fighting private investments in your portfolio, you can potentially mitigate the impact of inflation and help protect your purchasing power.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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