What persistent inflation means for long term investors
How the challenge ahead may reshape returns.
Whilst inflation has eased from the peaks of 2023, it appears that we’re not out of the woods yet. Data revealed the Consumer Price Index (CPI) ticked up to 3.8% in January, prompting the Reserve Bank to hand down their first rate hike in two years. But the real story for long term investors is bigger than a single data point.
For decades, Aussie investors have enjoyed a tailwind of low inflation and strong real returns across almost every asset class.It appears that era has ended. The question now is how to position portfolios in a world where inflation is stickier and returns are harder won.
What changes?
Over time, inflation quietly erodes the real value of money and shifts the way companies operate. This is why it’s often described as a silent thief. Although it’s hard to say whether the media frenzy surrounding inflation is ever silent.
As investors subjected to a 24-hour news cycle, we tend to worry about the dramatic, headline-grabbing periods of high inflation. We forget that even low to modest levels can be destructive over long horizons. The RBA’s target range for inflation has been between 2-3%, however this doesn’t necessarily imply that the range is a ‘safe’ number. Even if the figure lulls back down to target, it’ll still result in a significant loss of purchasing power without exposure to growth assets.
The chart below from Owen Analytics illustrates this clearly. It shows how different inflation rates affect the future purchasing power of a lump sum. If the CPI holds steady at a seemingly benign 2%, the real value of 100k is almost halved over 30 years. Naturally, the curve steepens as we enter higher rates. If we consider the latest data point (3.8%), 100k will be chopped down to just 67k within the next decade. This underscores the importance of investing in assets that grow at least in pace with inflation.
Source:Owen Analytics. December 2025.
Asset allocation during inflationary periods
Every investor wants their returns to exceed inflation. It’s the reason we turn to markets to build wealth. According to Vanguard, Aussie shares have returned 6.7% p.a. after inflation over the last three decades. During this period the CPI averaged 2.6% p.a. Since 1993 onward, inflation has fallen either within or below the 2-3% target band around 70% of the time. However, if we isolate the last five years, the picture is vastly different with the figure almost consistently above target range.
A high inflationary environment doesn’t favour higher returns. This creates issues for investors across the spectrum of their journey. Not only does it threaten retirees drawing down on savings, but also those who require high returns to meet their goals. So, where do we turn?
The graphic below from Owen Analytics illustrates real total returns since 1990 across a handful of asset classes during various levels of inflation. Whilst past performance is no indication of the future, it can give us a good idea of how each asset class has behaved.
The most striking aspect is that real returns from every asset class examined are higher in low inflationary periods and lower when inflation runs hot. This supports what we already know about inflation not being conducive to higher returns.
There is much speculation on what assets form the most effective inflation hedge. Contrary to popular belief, findings show that historically no asset class has performed better when inflation is higher. Lastly, Owen points out that the rankings of each asset stay relatively similar across every period. Growth assets have provided the highest real returns, deeming them the best hedge across the board.
Those with significant allocation to defensive assets such as cash and fixed income are most exposed to inflation-driven value erosion. The primary reason for this is that the income and capital repayments are fixed in nominal returns and those fixed dollars buy less as inflation rises. Interest rate hikes in response to inflation can also make existing bonds with lower fixed payments less attractive.
As an investor, it can be easy to fixate on the short-term performance of select asset classes and risk losing sight of the broader objective. For those who diversify broadly, it is important to remember that the overall resilience and long-term return of your portfolio should continue to mirror your goals.
Positioning your equity exposure
Rising interest rates shouldn’t drastically restructure the strategy behind your core portfolio (assuming it’s well aligned with your objectives). However, some investors may be inclined to tilt their portfolios to sectors or styles they believe might be primed to benefit.
The presence of high inflation creates a tougher backdrop for companies and their shareholders. From an operational perspective, labour and material costs rise, financing becomes expensive and consumers become more selective. Extended periods of higher interest rates and slower economic activity can put downward pressure on dividend growth. This is bad news for income investors who are already facing yields well below long-run averages.
Some parts of the market will naturally feel the sting more than others. You don’t need to be able to accurately predict the RBA’s next move to prepare for that. Morningstar Market Strategist, Lochlan Halloway recently explored sector performance across the four RBA tightening cycles since the late 1990s. It is important to note that this is simply illustrative and shouldn’t be over interpreted given each cycle was unique. His main goal was to identify which sectors have previously come under pressure when rates rise.
Industrials have been one of the more vulnerable areas as they often rely on heavy capital investment and are tied to rate‑sensitive parts of the economy. When financing becomes more expensive and activity cools, earnings are squeezed. The underperformance hasn’t been dramatic in past cycles, but it has been consistent.
Technology is the wildcard and in theory is one of the most rate‑sensitive sectors on the list. Tech companies generate cash flows far into the future, making them more vulnerable when discount rates rise. Historically, that’s meant the sector has struggled during monetary tightening phases. Although, the recent cycle did defy the trend thanks to the surge in AI optimism.
The takeaway for investors isn’t to exit from these sectors. In fact, periods of indiscriminate selling can create opportunities for long‑term investors willing to look past the cycle and focus on fundamentals.
What are some desirable traits?
Rising borrowing costs and a slowing economy can expose weaknesses in certain business models that might not be as clear in calmer conditions.
Companies with higher leverage tend to come under heat because refinancing becomes more expensive and interest expenses eat into profit. In contrast, those with stronger balance sheets are generally better positioned to weather tighter financial conditions. It also allows strategic flexibility to keep investing in growth while other competitors may be pulling back.
Companies that have shown the ability to consistently generate high returns on invested capital often have pricing power. Warren Buffett famously called out pricing power as the single-most important decision in evaluating a business. It is considered particularly valuable as it allows a company to raise prices without losing customers or market share. In Buffett’s words “if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business.” Stable earnings are a good sign of a company with pricing power and indicate a durable competitive advantage that can maintain profitability even if costs rise.
These traits don’t guarantee outperformance but may help tilt your portfolio toward businesses that are better equipped to navigate inflationary pressures and higher borrowing costs. The most important point I want to underscore is that sticky inflation doesn’t require a wholesale reinvention of a long‑term portfolio. If your asset allocation already aligns with your goals and time horizon, it’s still a solid foundation.
