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Investment Strategy: The Impact of Inflation Thumbnail

Investment Strategy: The Impact of Inflation

"I find it funny that people who didn't think there was any inflation in the pipeline are now talking about stagflation. This is nothing like the 1970's, which was a pretty dismal period, and not just because of polyester and disco." - Barry Ritholtz

You can't read about investments for very long without hearing about inflation. The concept may be a little difficult to understand, but basically, it comes down to the following: prices rise over time, causing your money to lose some purchasing power. If you could buy a car in 1980 for $5,500 and a comparable make and model for $49,000 in 2022, that speaks to the change in purchasing power. Sure, your 2022 model probably has a nicer stereo and several other value-added gizmos, but for the most part, your $5,500 doesn't have the same purchasing power in 2022 that it had in 1980.1

Along with taxes and longevity, inflation is one of the major risks that you will face in retirement. It is imperative that your retirement income plan ensures that your capital continues to grow even as your withdrawals increase to keep pace with the rising cost of living. Even at the long-term average inflation rate of 3%, a dollar will lose half of its purchasing power in 20 years. At the end of a 30-year retirement, something that cost $1.00 in the first year will now set you back about $2.40!

In 2022, we're seeing inflation like nothing we've encountered in decades. It has risen above 8% and sent prices through the roof. Inflation is charted in part by measuring the changes in what consumers pay through the Consumer Price Index against the Producer Price Index, which measures the prices that manufacturers receive for their products.

The main objective of the Federal Reserve, or simply the Fed, is to control inflation while at the same time avoiding a recession. A delicate balancing act to say the least. The Fed's ideal inflation rate is 2% over time. Currently, we are experiencing a much higher rate of inflation than what the Fed is comfortable with.

So what moves the needle? There are a number of factors, including demand-pull inflation, where demand for a good or service increases, but the supply filling that demand stays the same, causing prices to increase. The opposite can also be a factor with cost-push inflation, where the supply of a good or service is low, causing the prices to go up.2

What can you, as an investor, do to fight inflation? The general strategy, in this case, is to weather the storm, which can be helped in some ways by diversifying your portfolio. This often means a combination of equities and real estate or REITs. However, this typically only works if you are already invested as the inflation rises. Over the long term, U.S. equities handily outpace inflation. What about bonds? While it's true that the returns of bonds are more consistent than other investments, they are also much lower.1,2 Fixed income, as evidenced by its name, cannot rise to offset rising inflation.

Weathering high inflation periods can be difficult for investors, but sensible strategies and careful management may help you maneuver through the tumult.

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  1. https://www.forbes.com/advisor/investing/what-is-inflation/
  2. https://www.nerdwallet.com/article/insurance/do-you-need-renters-insurance

This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.