Inflation is coming. How should you adjust your investment strategy? A complete guide from tax optimization to asset allocation

Why Must Investors Understand the Concept of “Tax Adjustment”?

2022 became a turning point. Central banks in Europe and the US responded to record-breaking inflation with the most aggressive rate hikes in decades, eroding the purchasing power of consumers worldwide. In Spain, the inflation rate reached 6.8% by November 2022. Against this backdrop, an overlooked but crucial policy tool emerged—value adjustment (deflactar). Simply put, it involves the government readjusting tax brackets based on inflation levels to prevent taxpayers from being “overwhelmed” by nominal income increases.

This may sound like a cold tax trick, but it has a direct impact on your investment returns.

What is “Value Adjustment”? Why Do Economists Emphasize It?

Imagine a simple scenario: last year, your salary was 1,000,000, and you paid 200,000 in taxes. This year, due to inflation, your salary increased to 1,100,000. If the tax system makes no adjustments, you might owe 220,000 in taxes. On the surface, you earned 100,000 more, but in reality, your take-home pay is less—this is the “invisible theft” of inflation.

Economists refer to “value adjustment” as a solution to this problem. It involves using a number (called the adjustment coefficient) to eliminate the effects of price fluctuations, allowing us to accurately compare real economic performance across different periods.

For example: Country A’s GDP was 10 million euros in the first year and 12 million in the second. The apparent growth is 20%, but if prices also rose by 10% that year, the real growth is only about 9%. The 12 million expressed at the first year’s price level is roughly 10.9 million—this is real GDP (adjusted value), while the original 12 million is nominal GDP.

This logic also applies to tax systems. Adjusting IRPF (Spain’s personal income tax) based on inflation ensures that tax brackets automatically rise with inflation, preventing wage earners from being “taxed more” due to inflation.

The Policy Logic Behind IRPF Adjustments

Spain’s personal income tax (IRPF) is a progressive system—higher income, higher tax rate. The problem is, when inflation pushes up everyone’s nominal income, everyone is automatically pushed into higher tax brackets. Essentially, this is a form of “frozen” tax rates leading to a hidden tax increase.

What is the policy recommendation? Annually adjust tax thresholds based on the Consumer Price Index (CPI). This way, even if your nominal income increases, your real purchasing power remains unchanged, and you shouldn’t face higher tax rates.

This approach is standard in the US, France, and Nordic countries—annual adjustments are routine. Since 2008, Spain has not made such adjustments at the national level, although some autonomous regions announced local versions in late 2022.

The Double-Edged Sword of Policy: Who Are the Real Winners?

Supporters argue: This is the most direct way to protect the purchasing power of low- and middle-income groups. During high inflation years, not adjusting tax brackets amounts to disguised tax increases, which is clearly unfair.

Opponents’ arguments are more complex:

First, progressive taxation means high earners receive larger absolute tax reductions, which can exacerbate inequality.

Second, from a macro perspective, reducing the pressure on purchasing power can actually be a tool to control inflation. If the government eases tax burdens, consumers spend more, boosting demand, which can accelerate price increases—potentially fueling inflation.

Third, government revenue decreases, which could squeeze funding for public services like education and healthcare.

How much do individuals actually benefit? Not much. An average worker might save a few hundred euros per year—what seems like a “big relief” is actually quite limited.

How to Invest Under Inflation + Tightening Policies?

With central banks raising rates, governments tightening spending, and tax pressures mounting—asset performances vary greatly.

Defensive options: Precious metals and bonds

Gold is a classic safe haven during inflation. When fiat currencies depreciate and interest rates rise, gold— which doesn’t generate interest but preserves value—becomes attractive. Historically, gold has protected purchasing power over the long term, but short-term volatility is significant—2022’s gold market clearly demonstrated this.

Government bonds seem safe, but in high inflation, yields can be eroded. However, if central banks continue to hike rates, bond prices may rebound from lows. This is a typical “buy low” strategy—entering the market during high-rate periods.

Aggressive options: Stocks and forex

Stock markets in 2022 taught us a lesson: high interest rates and tightening policies are generally unfriendly to equities. Rising financing costs squeeze profits, leading to stock declines. But this isn’t always the case.

Energy companies, benefiting from soaring commodity prices, posted record profits, while tech stocks plunged due to higher borrowing costs. This indicates that stock-picking should shift from “overall bearish” to “sector-specific.” Companies providing essentials or energy—resilient to inflation—may perform well.

In other words, recession periods can be opportunities to buy quality assets at lower prices. Historically, investors who endure recessions often see substantial returns in subsequent years. The key is having cash on hand and patience.

Forex markets are more complex. High inflation often leads to currency depreciation, making foreign assets appear cheaper. But forex markets are highly volatile, and leverage trading carries huge risks—it’s a “fire” zone for ordinary investors.

Portfolio allocation ideas

Don’t put all your eggs in one basket. Under dual inflation and recession pressures:

• 20-30% in precious metals or ETFs (defensive)
• 30-40% in bonds or bond funds (steady cash flow)
• 30-40% in selected stocks or broad indices (long-term growth)
• 5-10% in alternative assets or foreign currency exposure (flexibility)

The core logic: inflation will eventually be controlled, and the economy will recover. Investors who enter now will benefit from future recovery.

Can Tax Optimization Change the Game?

If IRPF is truly adjusted, taxpayers’ disposable income increases. In theory, this could encourage more people to invest, especially in taxed assets like stocks and real estate.

But in reality, a few hundred euros in tax savings are unlikely to be the main driver of investment decisions. What truly influences investment are interest rates, economic outlooks, and risk appetite—these are the main players.

Final Advice

In an inflationary era, passive waiting isn’t effective. But don’t blindly chase the market. The key is:

Understand your real purchasing power loss—this matters more than nominal income growth.

Optimize tax planning—pay attention to policy windows like IRPF adjustments.

Build a balanced asset portfolio—a mix of inflation hedges, stable assets, and growth assets.

Maintain a long-term perspective—declines during recessions are often future buying opportunities.

Inflation and recession are part of the economic cycle, not the end. Well-prepared investors can always find opportunities amid crises.