Investment Strategy and Economic Factors
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Investment Strategy and Economic Factors
While there are many things you can control about your investment strategy, one thing you can’t control is how trends in the general economy will affect the performance and value of your investments. Neither can you make completely reliable predictions about what those trends will be. But general economic trends drive the performance of investments, so you have to make some determination to guide your decisions—and take precautions to minimize risk if you decide wrong.
Things To Know
- Inflation affects the values of certain investments.
- Changing interest rates affect the market values of bonds.
- Investors take advantage of business trends to invest in growing businesses, and many of them diversify their investments to balance risk.
Inflation
Inflation is the term for rising prices, generally driven by a greater demand for goods and services compared to the supply: "too much money chasing too few goods." Inflation is likely to be with us always. The question is, what will inflation rates do? This impacts more than simply the need for investments to outperform the inflation rate in order to show real gains in value. Anticipation about inflation trends also spurs the Federal Reserve to raise or lower interest rates, which impact the relative value of many kinds of securities.
Interest rates
Interest is the cost of borrowing money, and when you lend a company or government money by buying a bond or other debt instrument, the cost it pays is the income you make. By changing the interest rate it charges for loans, the Federal Reserve controls interest rates throughout the economy; and changing interest rates have a direct impact on the value of debt securities like bonds. When interest rates rise, bonds, most of which pay fixed rates of interest, are less valuable to investors; and when interest rates go down, the value of bonds goes up. Your choice of debt securities—and the amount of debt securities in your portfolio compared to other investments like stocks—will depend in part on where you think interest rates are going.
Business trends
Will a high-tech boom continue? Will falling consumer confidence lead to a decline in retail sales? Will a new industry grow or disappear? Trends in a particular area of business affect the performance of the companies that participate in that business—which in turn affects the economy as a whole. Business trends affect investment strategy in two main ways. Savvy investors want to take advantage of business trends to invest in growing businesses and stay away from those that may decline. Prudent investors diversify their portfolios to keep any one business trend from having too great an impact on their investments.
Your prediction about changes in these factors will have an influence on how you build your investment portfolio; and as economic factors change, the portfolio of a savvy investor changes along with them.
