It has been a long time since investors have had to worry about inflation. Suddenly it’s making headlines, because prices are rising faster than expected. What does that means and what can you do to protect your portfolio?
Before you start to worry about how inflation might affect your investments, let’s take a closer look at the facts behind the headlines.
What exactly is inflation?
While it may sound like cause for panic, inflation simply refers to the gradual rise in prices over time, meaning the dollars you have today won’t stretch as far tomorrow.1
This often happens because when there’s more demand than supply, prices will go up. And when an external event, like a natural disaster or a pandemic, makes it hard for companies to produce enough to keep up with consumer demand, they can raise their prices, resulting in inflation.2
This isn’t necessarily a bad thing. Stable, predictable inflation is actually considered a good sign for a growing economy.
Why is inflation rising?
Inflation is rising because prices are increasing faster than usual. But it’s useful to know that most measures of inflation compare what’s happening now with what was happening a year ago. And at this time last year, the U.S. economy shut down because of COVID-19. So be aware that the economic impact of the pandemic is going to distort any year-over-year comparisons for a while.3
Most importantly, what should you do about it?
That all depends on how long it sticks around. Many economists are expecting inflation to increase in the short term, but not to affect the economy as much as it has in the past.4
And the Federal Reserve is keeping a close eye on the situation. If it looks like inflation isn’t going to settle down later this year, they may take action to keep it in check.5
Either way, the important thing is to avoid having knee-jerk reactions. If you make big moves now to hedge against inflation, you could lose big if the inflation turns out to be temporary.
If inflation is going to stick around for a while, it may be appropriate to make some prudent adjustments, like considering higher future inflation estimates in your long-term income planning. But this all depends on individual factors, like what’s in your portfolio, and when you’re planning to retire.
This is definitely not a one-size-fits-all scenario, and this is where it helps to get personalized advice from your trusted financial advisor.