Understanding Inflation: What Investors Need to Know- 12.21
Michael D'Angelo- December 2021
Following a year of economic instability, it appears that many of us are turning our attention to something that’s been around for decades, but has recently gained international interest - inflation. In fact, a recent study found that people are Googling the word “inflation” at a rapid rate, with a peak not seen since 2008. With that being said, here’s a reminder about what inflation is and how it can affect you and your investments.
What Is Inflation?
Inflation is defined as an upward movement in the average level of prices. Each month, there is a report released, called the Consumer Price Index (CPI) to track these fluctuations.
Understanding the Consumer Price Index
The CPI was developed based on information provided by families and individuals on purchases made in the following categories:
- Food and beverages
- Medical care
- Education and communication
- Other groups and services
While it’s the commonly used indicator of inflation, the CPI has come under scrutiny. For example, the CPI rose 1.4 percent between January 2020 and January 2021 – a relatively small increase. A closer look at the report, however, shows the movement in prices on various goods tells a different story. Used car and truck prices, for example, rose 10 percent during those 12 months.
Investments & Inflation
Inflation can affect investments in several ways. Most notably, it can reduce the rate of return and risk our purchasing power as consumers.
Rate of Return
Inflation reduces the real rate of return on investments. Say an investment earned 6% over a 12-month period. During that time, let's say inflation averaged about 1.5%. That would mean that your investment’s real rate of return would have been 4.5%... not 6%.
Inflation puts your purchasing power at risk. When prices rise, a fixed amount of money has the power to purchase fewer goods and services. Imagine walking into a grocery store 10 years ago with $20. How many goods would you have been able to buy? How many goods are you able to buy with $20 today? This is a great example of understanding how our purchasing power diminishes over time!
With so many changes over the past year or so, it’s no wonder investors and consumers are concerned about the rate of inflation today. When inflation is low, it’s easy to overlook how rising prices are affecting a household budget. And when inflation is high, it may be tempting to make changes to your financial standings and portfolio. If you’re concerned about the inflation rates we’re seeing in 2021 and what’s in store for 2022, your trusted financial advisor can help determine if changes need to be made or if you and your portfolio are already well-prepared.