Lately, everywhere you turn people are concerned about rising inflation. The costs of items from groceries to automobiles and even real estate have increased significantly since the beginning of the year. But is inflation a good thing or a bad thing? Before answering that, let us review some of the basics of inflation.
What is inflation?
Think back to a purchase you made 10 years ago and how prices have risen since then. This gradual price increase of goods and services over time is what is known as inflation, and it causes a decline of purchasing power over time. Inflation is brought on by an increase in demand for goods and services that exceeds the available supply. This can be driven by various factors, such as excessive demand from consumers willing to pay more for the same goods and services. Another cause can be excessive growth in the economy or even government fiscal policy. When the government invests in infrastructure projects, it could trigger an increase in prices for the related goods and services. Also, by cutting taxes, more discretionary income remains available for spending and therefore consumers may be willing to pay more.
How does inflation affect me?
In addition to paying more for your ongoing purchases, inflation can also impact other areas of your financial picture such as your investments and even debt. Inflation indicates a strong economy, yet too much inflation can negatively impact companies’ profit margins and ultimately corporate earnings, which can impact stock prices. Commodities and certain sectors such as industrials and materials often perform well during periods of inflation. Cash and fixed income investments may potentially lose value if the earned interest rate is less than the inflationary rate. Borrowing activity may increase due to higher prices for items, which bodes well for lenders. At the same time, borrowers could end up repaying loans with money that is worth less than it was when originally borrowed, which is good for borrowers. It is important however to watch interest rates as they could also creep up in an effort to control inflation.
What to look for in the current environment?
With the economy rebounding significantly from the COVID-19 pandemic and more people getting vaccinated, travel for business and pleasure has picked up. This significant increase in travel has driven up the prices of hotels, air travel, car rentals, gasoline and even insurance. In addition, people are spending on what they previously could not during the pandemic (e.g., dining out, weddings, and in-person entertainment), which will continue to heat the economy.
Given what our economy has been through in the last year, it is not a bad thing to be discussing inflation right now. If this strong demand continues to climb beyond comfortable levels (around 2%), the Fed will likely step in and begin to raise interest rates to slow things down. This is an ideal time to review your investment portfolio to see if you are properly positioned. Also consider reviewing any outstanding loans or lines of credit to determine if any adjustments are needed.
Mariella Foley, CFP® is a Partner and Wealth Advisor with Round Table Wealth Management in Westfield. She can be reached directly at Mariella@roundtablewealth.com or 908-374-2570.