Asset allocation is the most important decision in determining portfolio returns. There are many factors that affect your portfolio asset allocation, but the macro inflation trend is one of the most important inputs in making this important decision.
Inflation trends have a profound effect on how a portfolio should be structured. Historical studies show asset categories perform substantially different when the inflation rate is rising from when the inflation rate is declining (disinflation), or when prices are actually falling (deflation).
Asset Allocation and Inflation
I have developed a short guide for each of these scenarios:
· Guide to Investing During Increasing Inflation
· Guide to Investing During Disinflation
· Guide to Investing During Deflation
Periodically make changes in your portfolio asset allocation to coincide with the probabilities of each inflation scenario. In reality you will rarely find time periods where you will know with certainty where the inflation rate will be in the short term. What an investor can do is assess the long term probabilities and trends to adjust their asset allocation to the probability of each scenario.
Using a tactical asset allocation strategy allows an investor to change their asset allocation depending on long term inflation trends and valuations of asset categories. If inflation is consistently rising allocate more dollars to investments in the increasing inflation guide. If inflation is high and falling, allocate more money to the investments in the disinflation guide. And finally if inflation starts to go negative, place more emphasis on the deflation guide.
Inflation Trend
An important aspect of investing is keeping track of economic conditions and the long term inflation trend. The direction of the rate of inflation is more important to portfolio performance than the actual rate of inflation at any particular time. Whatever the current rate is, the valuation of investments has already adjusted to that reality. In other words, the price of an investment already takes into account what the rate is today.
This is why the inflation trend is so important. Empirical studies show price movements of asset categories are correlated with the direction of the inflation trends, not the absolute number at any given time.
Asset allocation and the inflation trend are two critical concepts that require analysis and action for successful investing. This makes following economic conditions and keeping track of inflation trends an important aspect of asset allocation investing.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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