As 2023 continues to fly by, one topic that has garnered plenty of attention is inflation. One of the goals of retirement, 401(k), and investment planning in the long term is to outpace inflation. As such, it makes sense then that inflation has remained a concern throughout time for investors. It is important to understand how inflation works, and more specifically impacts your investments.
David Wentz of Tax Favored Benefits, Inc.
The past 15 months have seen rampant increases in inflation across many different segments of the consumer market. As such, the Federal Reserve began raising interest rates back in March of 2022 and has yet to hit the pause button on rate hikes. These robust changes to the Fed’s long-standing inflation policy further illustrate 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. It was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other groups and services.2
As 2023 continues to fly by, one topic that has garnered plenty of attention is inflation. One of the goals of retirement, 401(k), and investment planning in the long term is to outpace inflation. As such, it makes sense then that inflation has remained a concern throughout time for investors. It is important to understand how inflation works, and more specifically impacts your investments.
The past 15 months have seen rampant increases in inflation across many different segments of the consumer market. As such, the Federal Reserve began raising interest rates back in March of 2022 and has yet to hit the pause button on rate hikes. These robust changes to the Fed’s long-standing inflation policy further illustrate 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. It was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other groups and services.2
How Applicable Is the CPI? While it’s the commonly used indicator of inflation, the CPI has come under scrutiny in recent years. 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.3
As inflation rises and falls, three notable effects are observed:
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.4
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.
Empower Yourself with a Trusted Professional. 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 your financial professional to help you develop an investment strategy that takes both possible scenarios into account.
As I always say, remember that your financial advisor or plan representative works for you. Never hesitate to reach out to him or her with any question you may have about your account, retirement plan, or investing in general.
This Sponsored Column is by Tax Favored Benefits Inc., an Overland Park-based financial investment firm that works with clients to create custom wealth management strategies driving by your needs. Our experienced professionals provide a full suite of wealth, investment and retirement planning services to clients across the country.
We are able to help you achieve your version of personal and professional success because we put your best interests first, at all times and in all situations. It’s that simple.
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Citations
CNBC.com, August 27, 2020
Bureau of Labor Statistics, 2021
InflationData.com, 2021
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.
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