Inflation: What It Is and What You Can Do
If you scan the headlines or turn on the news, you can’t miss it: inflation. Inflation climbed to 5% over the past year, its fastest rate in 13 years. But what is inflation anyway, and should you be worried? This article provides a brief “Inflation 101” overview and offers tips to help protect yourself over the long term.
The Basics of Inflation
Simply put, inflation equals higher prices. Over the course of our lives, most goods and services have increased in cost. Everything from candy bars and coffee to cars and appliances have climbed in price over time, and that’s due in part to inflation.
But unless your income also rises, then inflation erodes your purchasing power. That’s what makes it particularly detrimental for low-wage employees and people on fixed incomes, such as some retirees.
The federal government, economists, and analysts commonly draw on two indexes in measuring inflation: the Consumer Price Index (CPI) from the Bureau of Labor Statistics and the Personal Consumption Expenditures (CPE) price index from the Bureau of Economic Analysis.
We don’t have the space in this article to delve into the indexes’ specifics, but suffice it to say, they can have important impacts on you. For instance, Social Security’s cost-of-living adjustments are pegged to the CPI for Urban Wage Earners and Clerical Workers.
Policymakers think some inflation is good for economic growth and strive to keep the inflation rate around 2%. But too much inflation can hurt both the economy and consumers. The Federal Reserve and other nations’ central banks may step in with monetary moves such as raising interest rates to dampen spending and slow down inflation.
The Fed has yet to commit to any action with the current surge in the inflation rate. As economic activity restarts post-pandemic, pent-up consumer demand seems to be driving the increase. Meanwhile, investors and analysts are watching for any moves from the Fed or the government in response to the climb in the inflation rate.
Inflation Pros and Cons
Having to spend more on your morning cup of coffee doesn’t sound like a great thing, but inflation can benefit you in other ways.
For one, your debt becomes less of a drain on your wallet. For instance, your fixed-rate mortgage will cost you the same amount over its duration, but the amount will represent a smaller portion of your salary each year (assuming your wages keep pace with inflation).
Inflation can also benefit your salary since wages tend to increase to keep up with inflation. It also tends to reduce the unemployment rate as companies hire more workers to keep up with the demand for goods and services.
On the other hand, inflation can reduce your standard of living. If your income doesn’t rise, then you need to stretch your money to pay for goods and services that are now more expensive.
Inflation can also affect your savings. If you’re holding your money in a regular savings account, the interest is probably not earning you enough to keep up with inflation over time. You might consider using a money market account or high-yield savings account such as those offered by online banks.
How to Protect Yourself Against Higher Inflation
Arguably, the most important step you can take is to invest in a well-diversified portfolio. Over time, the stock market has returned about 10%. And though historical returns provide no guarantee for future returns, equities provide an opportunity to counter inflation’s eroding effects.
Your asset allocation should include a percentage of equities and fixed income that helps you meet your return needs without taking undue risk with your money.
Although fixed-income securities like bonds may not be attractive when inflation climbs, they can help stabilize your portfolio when the stock market gets volatile. You may want to consider Treasury Inflation-Protected Securities (TIPS), which keep pace with inflation via the CPI.
Ideally, you will also invest in international equities to help balance any changes to the United States markets and economy.
Our fiduciary financial planning firm helps each client determine this balance based on their situation, and you may want to talk with a financial advisor to help determine yours.
In Summary
Inflation is a fact of life. You can help prepare your finances by taking prudent steps such as having a well-diversified investment portfolio. You may also want to talk with a financial advisor who can help you build a long-term financial plan that accounts for inflation, among other variables. We generally recommend a fee-only, fiduciary financial planner so that you receive advice that is in your best interest.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country's leading professional association of fee-only financial advisors.