2020 was a year of economic instability. Now that 2021 is upon us, many people are turning their attention to something that’s been around for decades, but has recently piqued national interest - inflation. In fact, a recent study found that the word “inflation” is being Googled at a rapid rate, with a peak not seen since 2008.1
Since the beginning of the COVID-19 pandemic, six major stimulus bills totaling roughly $5.3 trillion have passed. With the efforts to ease pandemic-fueled financial strife, are inflation levels being impacted?
Inflation is likely to pick up as the economy continues to recover from the pandemic according to Fed Chair Jerome Powell. He believes the inflation will be temporary, though. Powell has also stated that the central bank plans to keep short-term rates anchored near zero through 2023.2
Here’s a reminder about what inflation is and how it can affect you and your investments. Keep this information in mind as you consider any potential changes you want to make due to inflation we might be seeing this year.
Inflation, What Is It?
Inflation is defined as an upward movement in the average level of prices. Every month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) that tracks these fluctuations.
Understand the Consumer Price Index
The CPI was developed based on information provided by families and individuals on purchases made in the following categories:3
- Food and beverages
- Medical care
- Education and communication
- Other groups and services
While the CPI is the commonly used indicator of inflation, it has come under some scrutiny. For example, the CPI rose 1.4% between January 2020 and January 2021 – a relatively small increase. When you take a closer look at the report, however, the movement in prices on various goods tells a very different story. As an example, used car and truck prices rose 10% during those same 12 months.4
Investments & Inflation
There are many ways inflation can affect investments. Most notably, it can reduce the rate of return, risk purchasing power and influence the Federal Reserve.
Rate of Return
Inflation reduces the real rate of return on investments. Let’s 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 can also put your purchasing power at risk. When prices rise, a fixed amount of money has the power to purchase fewer goods and services. You are essentially getting less for your money.
The Federal Reserve
Inflation can also influence the actions of the Federal Reserve. If they choose to control inflation, the Federal Reserve has several ways in which it can reduce the amount of money that is in circulation. Speaking hypothetically, a smaller money supply means there will be less spending - which could equal lower prices and lower inflation.
Considering all the changes over the past year or so, it’s no wonder investors and consumers find themselves troubled about today’s rate of inflation. When inflation is low, it’s very easy to overlook how rising prices are affecting a household budget. Conversely, when inflation is high it may be tempting to make changes to your investment portfolio. If you are concerned about the inflation rates we have begun seeing in 2021, reach out to your trusted financial advisor. They can help you determine if changes need to be made or if you and your portfolio are already well-prepared.