What You Need To Know About The Relationship Between Inflation and Investing
Say you go to the grocery store and buy a loaf of bread for $2.50.
The following week, that same loaf of bread costs $2.57.
While that may not look like a lot on the surface, it could make your total bill far more costly. Inflation is everywhere, and the current high inflationary environment has investors concerned about their portfolios.
Here's what you should know about inflation today.
What's Happening With Current Inflation Levels?
For over a year now, inflation has been a hot news topic.
Because it’s been so high—7.5%. This is the most significant jump since 1982.
But what is inflation anyway, and why does it matter?
Inflation is the general increase in prices over time. That’s important because it denotes purchasing power.
When prices rise (inflation), goods and services become more expensive, meaning your dollar doesn't travel as far, and your purchasing power falls. That's why a trip to the movies costs $30 now instead of the few bucks it may have cost in the 60s. What used to be a .50 cent movie costs $14 now—and don’t forget the $12 small popcorn!
You can measure inflation with the CPI (consumer price index). Think of this as a benchmark for estimating the general price level of a collection of goods and services that the typical consumer might buy in a given year. Inflation is the change in the CPI from one period to the next.
Despite inflation's bad rap, it actually isn't all that bad in moderation. A price decline (deflation) can be just as alarming economically. To achieve price stability and find balance, the Fed generally sets a target for inflation at around 2%. So, a couple of percentage points per year marks a healthy economy.
Why Is Inflation So High Right Now?
There’s no single reason that inflation has increased. Several factors work together to make inflation so out of control. Let’s take a look.
Prices are determined by supply and demand. When demand exceeds supply, there is upward pressure on prices. We’re currently experiencing this phenomenon in spades.
Supply chain issues in the US and globally are vital factors driving supply down and inflation up. COVID-19 also has a lot to do with it. Some specific examples are
- Labor shortages. Many people chose not to work during, or return to work after, the peak of the COVID-19 pandemic for health concerns.
- Increase production costs. When goods cost more to produce, suppliers reduce the amount they are willing to sell at a given price because there is less profit.
- Government stimulus. Stimulating the economy too much and too quickly after COVID-19 via stimulus checks and other government aid increased demand. There is simply more money in the economy to chase products and services.
What Does Increased Inflation Have To Do With Your Investments?
When inflation gets out of hand, the Federal Reserve will take action by raising interest rates.
Here’s where investors tend to get uncomfortable. The Fed recently decided to start raising rates by 0.25%, and they will likely continue to raise rates into next year. Chairman Powell said he would be more “hawkish” with interest rate hikes (meaning the changes will be larger and more frequent).
This decision makes investors nervous because high-interest rates can mean bad news for stock returns. With higher interest rates, businesses have a greater borrowing cost, which depresses profits. Some investors may opt to buy bonds instead of stocks because the payout is relatively higher.
The good news is that consistent long-term investing is perhaps the best way to outpace inflation. Large US stocks like the ones represented by the S&P 500, for example, have had an average annual return of about 10% per year since 1926.
That’s why it’s essential to carefully consider your asset allocation and stay the course! When you do, you have a portfolio built with inflation in mind. Reacting emotionally and pulling money out of the market can do more harm than inflation because you miss the opportunity to “beat” it.
Work With A Team That Can Help
We understand that inflation can be scary. You don’t know how it might affect you or the long-term impacts on your investments. And investing can be complicated enough without any additional stressors.
We can help you build a comprehensive, diversified portfolio that gives you the tools to achieve your goals and keeps pace with inflation. Don’t let inflation prevent you from making progress, and don’t let it keep you up at night.
You can’t prevent it, but you can protect yourself from it. It's all a matter of incorporating it into your plan. Give us a call, and we will be happy to help you find a path forward.
First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.
Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust Department, or its employees provide tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.