I often see people asking what is the best place for my money to combat inflation.

The answers range widely but most commonly you will see property, index funds, individual stocks, type of stock, gold and bitcoin all thrown in the mix somewhere.

What is never mentioned though is cutting your spending.

To me, people tend to immediately go to the easy solution. It is much easier to guess which assets will outperform than it is to look at your spending and make some calls.

But this is the wrong way of looking at things. Of course you should always have a wide range of investments that match your goals, tolerance for risk and investing timeframes. But this shouldn’t change much regardless of whether inflation is high or not. It is inherently assumed that a long range portfolio will beat inflation. If you change your portfolio to try and further beat inflation it means you are changing your investment philosophy. To do so, you will now need to invest more aggressively than you initially wanted to. What if you pick the wrong asset class? Or what if the inflationary environment returns to a more normal environment sooner rather than later? This is timing the market and that has been proven to result in sub par investment returns. If you have a rock solid investment plan, you shouldn’t need to make changes to your investment portfolio no matter the market environment.

Instead of focussing on potential asset performance and correlation to inflation, you are much better off to focus on your own house.

1/. Ensure you have the right mix of assets to begin with. Widely diversified so that your short term needs are covered by conservative assets, such as cash and government bonds and your longer term needs are covered by growth assets, such as stocks and property.

2/. Look at your expenses. You are far better off cutting out some expenses than you are trying to eek out some extra investment dollars. For one, chasing results means taking on more risk than your investment allocation from point number one. Secondly, there is no guarantee of outperforming inflation over the short term whatever asset you decide on. Thirdly, cutting expenses has far greater impact than chasing inflation beating performance.

Let’s take Thomas and Jane, whose household spends $80,000 a year and they are investing $1,000 a month. Their first instinct is to try and get on top of inflation by changing their investments which are currently invested 70% towards stocks ($700 a month) and 30% towards bonds and cash ($300 a month). The bonds and cash were meant for their wedding in five years but they don’t like the thought of losing money to inflation. So they decide to invest $200 out of the $300 of bond allocation into the stock allocation.

Now, worst case scenario is they have less money than they put in in five years time for their wedding.

But let’s assume the market is kind to them, and they got lucky. Stocks returned a massive 5% more a year than their stocks and bonds. Let’s say 8% a year for stocks over 5 years vs 3% a year for bonds and cash. After 5 years, the extra $200 a month going into stocks would be $14,790, whereas if it went into bonds it would be $12,960. Almost $2,000 better off.

Now, if they were investing more per month or if the return discrepancy between stocks and bonds was higher, the difference would be more. But this example was pretty favourable towards stocks.

Thomas and Jane took on a lot more risk (90% in growth assets, instead of 70%), and with a very lucky result, were $2,000 better off. Over five years, $400 a year.

The worst case result was having a loss, or a return less than bonds.

Wouldn’t it be so much easier to save an extra $400 a year (in this example) instead of taking on all that uncertainty and extra risk?

It requires some introspection and analysis of your budget, but the impact is enormous. Once you have cut something from your budget once, you make those savings every month thereafter. It’s the infinite cash cow.

You also get to keep your desired asset allocation, so not taking on more risk than you need and the return from cutting your savings is guaranteed!

In this example $400 a year is less than $35 a month. Many of us can do this but we choose not to. A very small price to pay to keep your desired asset allocation and to stop having to chase inflation.

If you can cut your expenses, that will have a far greater impact on your ability to absorb the effects of inflation, than chasing investment performance and trying to time the market will. In fact, the latter approach is more likely to slow you down than speed you up.

So get your own house sorted and you shouldn’t feel the need to chase inflation. For if you do, then your investment planning wasn’t right in the first place.

The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here