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Inflation has been one of the main stories of the year, sweeping away a growing part of the world economy. How can employers and entrepreneurs protect themselves and their financial future in times like these? Bernstein Alliance experts Chris Brigham, Matt Palazzolo and Adam Sansiveri explain.
Impact of inflation on entrepreneurs
Entrepreneurs face inflationary pressures in two main ways. One is similar to other people: the impact that inflation has on their investment portfolios and their future purchasing power. The second is unique: the impact it has on your business.
What to do with inflation depends largely on its sensitivity. Inflation protection involves compensations that make a lot of sense to some people and make less sense to others. In general, your exposure to inflation is a function of three variables: the proportion of your wealth in stocks versus bonds, when you plan to retire (or if you are already retired), and your desired level of spending. More actions, more retirement years, and less spending reduce your sensitivity to inflation.
Employers, however, may have unusual portfolios compared to the general population. That is, they may have a large share of their net worth tied to their business.
One consideration is how you think about your wealth from your business. Do you focus mainly on the income you generate or do you think about the value of capital that would be worth a sale? This often depends on the maturity of your business and your age and financial plan.
Related: Inflation is a risk to your business, but it doesn’t have to mean bad luck
Your business vs. value indices
Owning your own business is a share of capital, similar to investing in public stocks, that usually offers a fair degree of protection against inflation. However, we believe that investing in public equities is a diversified portfolio, while your financial position may be abnormally exposed to the fundamentals of your industry and its structure. One of the key questions to ask is to what extent can you increase prices without sacrificing sales, and how sensitive is your business to inflation?
We can see the difference considering how different Coca-Cola and 3M behaved earlier this year. Coca-Cola increased its sales by 7% through price and combination changes, while managing to sell 11% more volumes than a year earlier, with an organic revenue growth of 18%. On the other hand, 3M tried to raise prices, but it seems that it has still lost sales volumes in the process.
Which of these results is most similar to what your business would face? You can think about it based on the growth trends in your industry and the benefits that make it difficult for competitors to gain market share even when prices go up. The answer is how much protection you should have in the rest of your portfolio.
Protect your wallet
How is this portfolio protection? Depending on your asset mix and the size and sensitivity of your business inflation, there are different ways to protect your portfolio from inflation. A critical point here is that inflation can be difficult to predict, so we consider protection against inflation to be like an insurance policy. These ideas are not tactical; if you are sensitive to inflation, they should be in your long-term strategic asset allocation.
Related: How to use alternative assets as a hedge against inflation
In general, our most inflation-sensitive clients have large fixed-income portfolios. For them, the key is to include inflation-protected bonds in their portfolios. We typically do this including Treasury inflation-protected securities (TIPS) or inflation swaps, depending on your tax bracket.
Investors with more than their portfolios in stocks that are still sensitive to inflation may want to replace part of their diversified holdings with a combination of commodity futures and stocks in industries that have pricing power.
Accredited investors or qualified buyers may find attractive inflation-protected opportunities in alternative asset classes such as private credit, real estate and hedge funds.
Protect your business
Here’s what you can do for your wallet. What about your business?
Think carefully about the price / volume compensation you have. Similarly, with employees looking for pay raises, find out how much they are willing and able to give when it comes to pay raises. Are There Other Ways to Increase the Recognition or Happiness of Your Employees? For companies with rising commodity costs, you may be able to reduce the volatility of your input costs by contracting with your suppliers in advance or by covering the costs of commodities through commodity futures. The hope is not to make money with coverage, but to allow you to better plan your business and smooth your cash flows.
Inflation is hard on everyone, including business people and business people. Achieving this in an informed way, with a strategic plan, will be able to weather the storm.
The views expressed herein do not constitute research, investment advice or business advice and do not necessarily represent the views of all AB portfolio management teams. Views are subject to change over time. Bernstein does not offer legal or tax advice.