As the year presses on, I wanted to touch on the inflation and investments issue we’ve been experiencing for the past few months. I hear a lot from clients about their concerns and general worry about the issue, and I wanted to chime in today and touch on a few major points to help shed some light on this topic.
If you have specific questions about what inflation means for your portfolio or need some insight into your personal circumstances, give our office a call and we’ll get your questions answered the best that we can.
Inflation, Investments, and the Market
You see it in prices at the grocery store and the gas station. You feel it in your monthly budget. So why is it that the financial markets don’t seem too concerned about inflation and investments?
Remember, financial markets are considered “discounting mechanisms,” meaning they are looking six- to nine-months into the future.
Related: Market Cycles and Retirement: Sequence of Return Risks in Portfolios
Judging Inflation and Investments with the Baltic Dry Index
One lesser-known indicator helps support that forecast is called the Baltic Dry Index.
It measures the cost of transporting raw materials, such as coal and steel. The index has been trending lower for several weeks, which in the past has suggested that prices may be more manageable in the months ahead.2
No inflation indicator is fool-proof.
That’s why the Baltic Dry Index is just one of the many indicators that our professionals follow when watching inflation. They also keep a close eye on the Fed, which is responsible for controlling inflation.3
With the economy improving, the Federal Reserve has indicated it will be tapering bond purchases, which may help with inflation. The Fed also has prepared the markets for higher interest rates in 2022. That, too, may help.4
These robust changes to the Fed’s long-standing inflation policy further illustrates the importance of understanding how inflation is reported and how it can affect your investments.
What Is Inflation?
Inflation is defined as an upward movement in the average level of prices. Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) to track these fluctuations.
The CPI was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories:
- Food and beverages
- Medical care
- And other groups and services.5
How Applicable is the CPI?
While it’s the commonly used indicator of inflation, the CPI has come under scrutiny. For example, the CPI rose 1.4 percent for the 12-months ending in January 2021 – a relatively small increase. However, a closer look at the report shows movement in prices on a more detailed level. Used car and truck prices, for example, rose 10 percent during those 12 months.6
As inflation rises and falls, there’s three notable effects:
First, inflation reduces the real rate of return on investments.
So, if an investment earned 6 percent for a 12-month period, and inflation averaged 1.5 percent over that time, the investment’s real rate of return would have been 4.5 percent. If taxes are considered, the real rate of return may be reduced even further.7
Second, inflation puts purchasing power at risk.
When prices rise, a fixed amount of money has the power to purchase fewer and fewer goods.
Third, inflation can influence the actions of the Federal Reserve.
If the Fed wants to control inflation, it has various methods for reducing the amount of money in circulation. Hypothetically, a smaller supply of money would lead to less spending, which may lead to lower prices and lower inflation.
Related: The Impact of Rising Rates
Empower Yourself with a Trusted, Professional Partner
When inflation is low, it’s easy to overlook how rising prices are affecting a household budget. On the other hand, when inflation trends higher, it may be tempting to make more sweeping changes in response to increasing prices.
The best approach may be to reach out to our offices and we’ll help you develop an investment strategy that takes both possible scenarios into account.
The WAG Team has been working on creating a great guide for you to help navigate inflation and investments. This guide goes over key points that can help you better understand the environment, as well as give you some options that may help cushion the impact of inflation.
We’ll explore how the current economic environment — including high inflation and rising interest rates — could impact your plan for retirement and what steps you can take to help plan.
Inflation and Investments: What the Future Holds…
For now, it’s important to understand that inflation can influence interest rates, which often play a role in how a portfolio is constructed.
We’re keenly focused on what’s next for inflation to determine if any portfolio changes are appropriate in the future. If you have specific questions about this, give us a call and we can schedule some time to go over what this environment means for your finances.
My goal is to help navigate and provide all the education I can to help you make the right decision for your personal circumstances and plan out personalized strategies for your future goals.
We’re happy to work with you either in person, over the phone, or virtually, based on your preference. Give our office a call and we can schedule some time together.
1. Investopedia.com, 2021
2. CNBC.com, November 10, 2021
3. ClevelandFed.org, 2021
4. CNBC.com, November 3, 2021
5. Bureau of Labor Statistics, 2021
6. InflationData.com, 2021
7. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments. Past performance does not guarantee future results.