Inflation is everywhere, both in the news and in daily life. You may be wondering how that affects you.
First, what is inflation? Google result: “A general increase in prices and fall in the purchasing value of money.” I like that definition even though it seems redundant and said again.
“A general increase in prices”: We’ve all experienced this as of late, and though volumes have been and could be written about the reasons for increases and the “transitory” (i.e. temporary) expectations for some specific increases, let’s just agree that the government has lately reported the highest inflation numbers in 40 years.
An aside: There are some very real price increases that aren’t included in inflation. For example, my 2007 CR-V doesn’t have a single camera in it, doesn’t have Bluetooth, can’t parallel park or drive itself, and has far less advanced safety features than any new car sold today. All those features make a new car cost more, but that isn’t inflation. Why not? Because you’re not buying the same, directly comparable thing. You’re buying a far more advanced, similar thing that should cost more. In fact, it is only the recent increase in used car prices (where the directly comparable thing is bought again) that has caused car prices to contribute to inflation at all. For the previous 20 years, increasing car prices did not contribute to official inflation numbers!
“A fall in the purchasing power of money”: Once more putting redundancy aside again, this little phrase is a gem, because what is money but purchasing power? For savers, the negative impact of inflation is a loss in purchasing power, a diminished capacity to buy goods and services. Inflation means your investments can buy less.
For borrowers, like mortgage holders or the U.S. government, inflation can be pretty great. If you have a $1,000 mortgage payment and year-over-year inflation is 6%, within one year, the real purchasing power cost of your mortgage drops to about $940. Assuming you made more money to keep up with inflation, your household buying power increased because the true, buying-power cost of your mortgage payment went down. If your mortgage was a stretch when you first bought your home, and now it’s no big deal, this is one reason why.
To summarize the previous two paragraphs, high inflation is bad for savers but favorable for borrowers and the U.S. government’s ability to service its debt. That is why you might have read that “inflation is a tax.” Inflation is not literally enshrined in the tax code, but it does transfer invisible value from your savings to the government.
What does this mean for investors? It means your goal should be to maintain and increase your buying power. To do that, your investments have to keep up with and beat inflation. There are some things that generally keep up with inflation over the long-term, like gold or real estate. Yet, those “inflation hedges” can – just like many other asset classes – be terrible short-term investments. For instance, gold had calendar year losses in 5 of the last 10 years, including two double-digit declines. That kind of short-term, up-and-down volatility means gold isn’t suitable for parking money you need in a year.
Likewise, stocks experience tumultuous up-and-down volatility in the short run. However, unlike inflation-pacing assets, stocks have outpaced inflation by more than 7% annually since 1926. That 7% real return is the reward for suffering stock volatility, for looking at statements where your balance has dropped while inflation runs rampant. Over the long run, stocks have kept up with and beat inflation, increasing buying power. To one more time repeat myself yet again, maintaining and increasing your buying power over time is the goal.
If you or someone you know would like to have a conversation about what inflation means for your investments, please reach out to schedule a planning session or to arrange an introduction.
Kyle Swan, CFP®
Securities and advisory services offered through Mutual of Omaha Investor Services, Inc. Member FINRA/SIPC. Mutual of Omaha Advisors is a division of Mutual of Omaha Insurance Company.
Comments