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Inflation. Inflation is the term for
rising prices, which are generally driven by a demand for goods and services
that is greater than 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 to show real gains in value. Anticipation about inflation
trends also spurs the Federal Reserve to raise or lower interest rates, which
affect the relative values 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 they pay 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 effect on the
value of debt securities like bonds. When interest rates rise, bonds, 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 high-tech booms 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. |
