How to fight inflation in your portfolio

Whether you are filling up your gas tank or stocking up the refrigerator with groceries, prices everywhere seem to be higher.

Last year we saw consumer prices increase by 7%, the largest increase in nearly 40 years. Americans are now faced with something they haven't had to worry much about over the past 30 years, inflation.

What's causing the increased inflation? Supply chain disruptions due to COVID-19 and the increase in the money supply are the two main factors. The coronavirus shutdowns created a bottleneck in supply chains. Factories were not able to produce goods while demand remained high. Combine this with the increase to the money supply due to the stimulus packages and you have a scenario of high demand with limited supply - a perfect equation for rising prices.

How long will it last, how high will it get? Back in early 2021 when we started to see the first signs of rising inflation, the Federal Reserve labeled the increase in prices as "transitory" or temporary.

They have since acknowledged that inflation has been stickier than initially expected. However, they do expect inflation to begin to calm this year and their long-term expectations for inflation are in the low 2 percent range.

However, some economists disagree with the Fed's optimistic outlook and believe this elevated level of inflation will be with us for a few years until the effects of the coronavirus shutdowns have worked their way through the economy. It's also important to keep in mind there are two types of inflation, sticky and flexible.

Sticky inflation tends to hang around longer. Fortunately, we've seen the biggest increase in flexible inflation, things like food, energy and commodities. Price increases in those areas tend to be more short term.

Think of lumber prices back in 2021. We saw the price of lumber skyrocket in the first half of 2021 before coming back down the second half of the year.

How do I protect my portfolio from inflation? Inflation is not always a bad thing. For example, moderate inflation has been a good thing for markets because it usually indicates a strong economy.

The risk comes with rising and high inflation. Fortunately, not all asset classes react the same way when inflation rises. There have been eight periods of rising inflation since 1970 and there have been four asset classes that have provided the best returns during those times.

Investors need to be aware of how their assets are allocated to make sure they are in the proper areas to minimize the harmful effects of inflation.

Also, with rising inflation usually comes higher interest rates. The Fed has already hinted at increasing interest rates sooner than expected due to increased inflation. On the one hand, savers can expect to earn a higher interest rate on their short-term savings and money market accounts. On the other hand, bond investors need to be aware of the interest rate risk their portfolio has.

Bonds have an inverse relationship to interest rates. When rates go up, bond prices decline. That doesn't mean you should avoid bonds; you just have to be sure you're properly positioned to manage the risk.

The future is always uncertain, but it's that uncertainty that gives investors the opportunity for profit. Investors need to stay calm and review their portfolio's design before making rash decisions. I believe a properly balanced portfolio can help investors thrive in the years ahead.

• John P. Daly is the founder of Daly Investment Management LLC, a Registered Investment Adviser specializing in wealth management and retirement planning. For more information, please visit www.dalyinvestment.com