Tariffs and Your Portfolio

If you have been following the headlines, you have seen the word “tariff” quite a lot.

What Are Tariffs?

Tariffs are a tax on foreign goods, paid to the government by the entity importing the goods to the domestic country. This tax makes foreign goods more expensive to domestic consumers, and/or less profitable for the foreign manufacturers. The idea is usually to make domestic alternatives more attractive,  protect local industries, or drive domestic investment.

First, it is important to clarify how tariffs work. For this example, we will use a hypothetical company “Go USA Inc.” who makes widgets Wisconsin using raw materials sourced in Ohio. “Go USA’s” main competitor, “FX Now, Inc” also produces similar widgets in Wisconsin, but source their raw materials from Wakanda because they cost less. The fictitious country of Wakanda has a 50% tariff.

Here is a hypothetical market scenario before and after tariffs are enforced. Widgets sell for $10 each.

Go USA can source their raw materials for $7 each so each unit sold earns them a $3 profit. FX Now sources their raw materials from Wakanda at a much lower price of $5 each.

Under this scenario, if Go USA and FX Now both sell for $10 (widgets are identical) in the pre-tariff market, FX Now should be more profitable than Go USA’s operations.

When tariffs are enforced, FX Now will not be as profitable. In response, they may either raise prices (which Go USA may do so as well), look to lower the price of their raw materials, or accept lower profits. The net effect might be higher prices for consumers or less profitability for companies.

Why Tariffs matter for Investors

This simplistic example is how tariffs work, but there are many other issues at play. At the same time, they can have a large effect on the markets – especially in the short-term.

Here is why:

• Earnings – Higher costs can eat into corporate profits.

• Inflation – If tariffs increase selling prices, inflation can rise which may lead to higher interest rates.

• Consumer Behavior – When products get more expensive, consumers might cut back on purchases.

• Global Growth – Tariff wars can slow down global trade, hurting economies abroad (and here in the U.S.)

Put simply, tariffs can act like a tax on growth – and the market tends to price this in.

What Should You Do?

Here is the good news: while tariffs can rattle markets in the short run, they rarely derail a well-diversified long-term portfolio. The key is to avoid overreacting to headlines, as the market conditions may change abruptly, and these changes can be very difficult to predict.