HOW DOES INFLATION AFFECT ME?
If it seems like many of the items you buy have gotten more expensive, you’re right! After hovering at low levels for the better part of the last three decades, inflation has been on the rise since the start of the year. That means each trip to the grocery store, the gas station, or the doctor’s office takes a little more money out of your pocket than it used to.
What Is Inflation?
Inflation is the general rise in the price of goods and services in an economy that reduces the purchasing power of a currency. Some degree of inflation is viewed as a positive, as it signals economic growth. Too much inflation, however, poses a problem – unless your paycheck is rising as much as the cost of goods and services.
How Is Inflation Measured?
While there are several different measures of inflation, the consumer price index (CPI) and the personal consumption expenditures (PCE) price index are among the most widely used. While both indexes track changes in the prices of goods and services over time, they are constructed differently and thus tend to behave differently. You can measure it by how much more you spend to buy the same groceries, to fill up your tank with gas, or what you are paying to heat your home now versus a year ago.
What Causes Inflation?
When describing the causes of inflation, economists often use the phrase “too many dollars chasing too few goods.” A strong economy with high levels of employment often means that consumers have more money to spend. When the production of goods can’t keep pace with the number of interested buyers, it places upward pressure on prices.
Supply interruptions and shortages of key commodities can also spark inflation. As we saw during the COVID-19 pandemic, supply chains were disrupted and resulted in global shortages in a wide range of goods, from lumber to computer chips. We’ve also witnessed it over the years when the price of oil jumps, triggering a chain reaction as producers pass higher costs along to consumers.
Monetary policy is yet another cause of inflation. The Federal Reserve’s (Fed’s) policies can sometimes lead to inflationary pressures. Too much fiscal stimulus or expansionary fiscal policy can result in “too many dollars chasing too few goods.”
What Are the Effects of Inflation?
Inflation decreases the purchasing power of your dollars. While it impacts everyone, it typically hits retirees and anyone else on a fixed income the hardest. It’s important to note, however, that Social Security benefits are adjusted to reflect increases in the CPI through a Cost-of-Living Adjustment (COLA). Another common side effect of inflation is higher interest rates, as raising interest rates is a tool the Fed uses to keep inflation under control. This means borrowers will pay higher interest rates on mortgages, credit cards, and other loans. It can also negatively affect the market value of existing bonds, particularly those with longer durations. Excess or idle cash in savings accounts, money markets, and CDs typically won’t keep pace with inflation.
What Can I Do About Inflation?
You should evaluate your long-term bonds and lower quality bonds, as inflation can suppress the market values of these types of positions, effecting the price you would receive if sold prior to maturity. Also review your cash-type products and consider redeploying idle cash that is not earmarked for future spending or your emergency fund.
Treasury inflation-protected securities (TIPS) are one way to fight inflation. Issued by the U.S. Treasury, these bonds are indexed to the rate of inflation, as measured by the CPI. So when the CPI rises, so does the principal value of TIPS.
Stocks can be a hedge against inflation because they typically earn more over an investment cycle than inflation. Even older investors and retirees can allocate a portion of their portfolio to stocks to help them maintain their purchasing power over time. Of course, while history shows that stocks provide greater protection against inflation, they also come with more risk.
To learn more about how to insulate your portfolio from the effects of inflation, contact us!
What Is Inflation?
Inflation is the general rise in the price of goods and services in an economy that reduces the purchasing power of a currency. Some degree of inflation is viewed as a positive, as it signals economic growth. Too much inflation, however, poses a problem – unless your paycheck is rising as much as the cost of goods and services.
How Is Inflation Measured?
While there are several different measures of inflation, the consumer price index (CPI) and the personal consumption expenditures (PCE) price index are among the most widely used. While both indexes track changes in the prices of goods and services over time, they are constructed differently and thus tend to behave differently. You can measure it by how much more you spend to buy the same groceries, to fill up your tank with gas, or what you are paying to heat your home now versus a year ago.
What Causes Inflation?
When describing the causes of inflation, economists often use the phrase “too many dollars chasing too few goods.” A strong economy with high levels of employment often means that consumers have more money to spend. When the production of goods can’t keep pace with the number of interested buyers, it places upward pressure on prices.
Supply interruptions and shortages of key commodities can also spark inflation. As we saw during the COVID-19 pandemic, supply chains were disrupted and resulted in global shortages in a wide range of goods, from lumber to computer chips. We’ve also witnessed it over the years when the price of oil jumps, triggering a chain reaction as producers pass higher costs along to consumers.
Monetary policy is yet another cause of inflation. The Federal Reserve’s (Fed’s) policies can sometimes lead to inflationary pressures. Too much fiscal stimulus or expansionary fiscal policy can result in “too many dollars chasing too few goods.”
What Are the Effects of Inflation?
Inflation decreases the purchasing power of your dollars. While it impacts everyone, it typically hits retirees and anyone else on a fixed income the hardest. It’s important to note, however, that Social Security benefits are adjusted to reflect increases in the CPI through a Cost-of-Living Adjustment (COLA). Another common side effect of inflation is higher interest rates, as raising interest rates is a tool the Fed uses to keep inflation under control. This means borrowers will pay higher interest rates on mortgages, credit cards, and other loans. It can also negatively affect the market value of existing bonds, particularly those with longer durations. Excess or idle cash in savings accounts, money markets, and CDs typically won’t keep pace with inflation.
What Can I Do About Inflation?
You should evaluate your long-term bonds and lower quality bonds, as inflation can suppress the market values of these types of positions, effecting the price you would receive if sold prior to maturity. Also review your cash-type products and consider redeploying idle cash that is not earmarked for future spending or your emergency fund.
Treasury inflation-protected securities (TIPS) are one way to fight inflation. Issued by the U.S. Treasury, these bonds are indexed to the rate of inflation, as measured by the CPI. So when the CPI rises, so does the principal value of TIPS.
Stocks can be a hedge against inflation because they typically earn more over an investment cycle than inflation. Even older investors and retirees can allocate a portion of their portfolio to stocks to help them maintain their purchasing power over time. Of course, while history shows that stocks provide greater protection against inflation, they also come with more risk.
To learn more about how to insulate your portfolio from the effects of inflation, contact us!
Kletschke Wealth Management Group
400 Gold Circle, Suite 220
Dakota Dunes, South Dakota 57049
(712) 252-6931
KWMG@stifel.com