Managing Money in the Face of Inflation
STEVE INSKEEP, host:
On Fridays, the business report focuses on your money, and today we'll report on what happens when your money is worth less. Inflation rose last month by the highest rate in 25 years, mostly boosted by high gasoline prices. To get some historical perspective on investing when you're concerned about inflation, we spoke to Jonathan Clements. He's the personal finance columnist at The Wall Street Journal.
Mr. JONATHAN CLEMENTS (Personal Finance Columnist, The Wall Street Journal): The financial story of the past quarter-century has been the decline in the inflation rate. And we've gone from 12, 13 percent inflation in '79 and 1980 down to 3 percent in recent years. And that fall in the inflation rate has had a hugely beneficial effect across the economy. I mean, as inflation has fallen, interest rates have fallen. As interest rates have fallen, that's not only driven up bond prices; it's also made stocks more attractive. It's helped to fuel the recent real estate boom. But--but--what happens if inflation comes back? And that's why everybody's so focused on the inflation rate right now.
INSKEEP: So what can the average person do to protect himself or herself against inflation?
Mr. CLEMENTS: Well, one of the things is you look at your portfolio. What you might want to think about doing is favoring the shorter end of the bond market. You don't want to be in long-term bonds when inflation and interest rates are going up because you're going to be locked into this low interest rate for a long, long time. So if you're investing in bonds, you really want to be in short-term bonds.
INSKEEP: Just to make this clear, the fear is that if you bought a bunch of bonds at a low interest rate, inflation rises, suddenly you might be losing money, in effect.
Mr. CLEMENTS: You'll be stuck with this low--earning this low yield for years and years and years. So if you're investing in bonds today, it's much better to go and buy a two-year bond and just be stuck with that low interest rate for two years than to go out and buy a 20-year bond and be stuck with that low interest rate for 20 years.
INSKEEP: Now what about other financial tools?
Mr. CLEMENTS: Well, one of the biggest things out there is what's going to happen with real estate and mortgages. I mean, clearly, if inflation goes up and interest rates go up, people are going to find it more difficult to manage those mortgage payments, so they're going to bid less for home prices, and so home prices may stop rising at the rate we've seen. If you've got an adjustable-rate mortgage right now, your payments are going to go up. That's one of the reasons why, if you're out there getting a new mortgage today, you might want to get a fixed-rate mortgage. It may mean a higher initial payment, but at least you won't be affected if interest rates go up.
INSKEEP: Are there other things you can do to lock in the good situation now and avoid the risk later?
Mr. CLEMENTS: Basically being a borrower is not a bad thing to be in an inflationary environment. I mean, one of the things that we've seen the last couple of years, we've seen people go out and borrow huge amounts of money to buy homes, you know, and if we're feeling moralistic, we'd like these people to be punished for their excesses. But the reality is, if we get a burst of inflation, all those people who have gone out and borrowed lots of money, particularly if they've borrowed it at fixed rates, are actually going to be in great shape because they're going to have this great low-interest loan in an environment where inflation and interest rates are going up.
INSKEEP: What should people who've invested in a lot of stocks do in an inflationary culture?
Mr. CLEMENTS: If we get a rise in interest rates, in the short term, stocks are likely to do relatively poorly, but long term, if inflation is coming back, stocks actually won't be a bad place to be because with stocks, you basically have a claim on a real asset. You have a claim on these corporations which are able to raise their prices along with the inflation rate. So as inflation rises, corporate profits should rise. So in the long term, stocks can actually be a good hedge against inflation.
INSKEEP: Jonathan Clements is personal finance columnist for The Wall Street Journal.
Thanks very much.
Mr. CLEMENTS: It's my pleasure.
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