Recent readings have put the topic of inflation in the spotlight in a large way, attracting the attention of economists, investment managers, and the average investor.
In its simplest form, the concept of inflation is widely understood: a loaf of bread costs more today than it did 30 years ago. In technical terms, inflation is defined as “a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.”
The cause of inflation can be derived from this definition. For a recent example, we can look at the COVID-19 pandemic and its impact on the investment markets and economy. Massive distributions, in the form of stimulus payments, put cash directly into the hands of individuals and business owners throughout 2020 and 2021. Additionally, low interest rates (controlled in large part by the Federal Reserve) made borrowing cheap. Those two factors affected the “volume of money and credit.”
The economy bounced back aggressively in the second half of 2020; but while spending intensified (due to incoming stimulus), the availability of goods and services did not. Prolonged manufacturing delays, supply chain shortages, and labor force issues have had ripple effects across the economy, ever since COVID-19 became a part of our everyday lives. This is the “available goods and services” portion of the definition.
This divergence in supply and demand resulted in huge increases on everything from home prices (due to low interest rates) and vehicles (due to semi-conductor shortages) to the cost of raw materials and everyday goods, leading to the highest inflation readings that we’ve seen in four decades. The Russia/Ukraine war has since added fuel to the fire, causing further price increases on oil and other raw materials.
In a steady state environment, inflation is to be expected and is a sign of a healthy economy. However, when inflation accelerates too quickly it can have negative consequences, and in a worst-case scenario, can hurt spending enough to push us into a recession. Looking backwards, the inflation we’re seeing now is the culmination of a perfect storm of factors; but that doesn’t make it any more pleasant for our wallets.
During times like these, we often get questions about how to protect against prolonged inflation. Generally speaking, the best way to fight inflation over time is to own stock. More specifically, value stocks or “blue chip stocks,” are historically good places to invest during inflationary times. Even for retirees, having stocks in your portfolio (within the constraints of your risk profile) is important to ensure that your assets grow at a rate that will outpace rising prices. Generally speaking, these “value stock” companies have strong balance sheets and are able to offset higher input costs with higher prices for the consumer, meaning they are not impacted as adversely by the increased cost of raw goods. Additionally, they produce a relatively higher current income stream (via dividends) to investors. In a rising inflation environment, it’s very obvious that a dollar today is worth more than a dollar in the future.
Eventually, we think inflation will naturally fall to normal rates (around 2-3%), as the Fed fights to de-stimulate the capital markets and economy, and lingering supply chain issues are resolved. However, it is important to remember that inflation is a normal (and important) part of our economy. At Pathfinder Wealth Consulting, we stress test our clients’ financial plans with real-world scenarios every day. Our goal is to help our clients build a financial plan that aligns with their goals today and into the future, no matter the obstacles along life’s path. If you would like to talk about how your financial future will stand the test of time (and inflation), give us a call at 910-793-0616. We are here to guide you forward.
This material is for general informational purposes only and does not constitute a recommendation, a course of action or offer to sell or a solicitation of an offer to buy any security which may be referenced herein. Individual circumstances vary. We suggest that you consult with your financial, legal or tax advisor with regard to your own individual situation.