September 2020
Financial Planning

If it feels like your dollar doesn’t go quite as far as it used to, you aren’t imagining it. The reason is inflation, which describes the rise in prices and slow decline in purchasing power of your dollars over time. The impact of inflation may seem small in the short term, but over the course of years and decades, inflation can drastically erode the purchasing power of your savings. Here’s how to understand inflation, and steps you can take to protect the value of your money. 

Inflation occurs when prices rise, decreasing the purchasing power of your dollars. In 1980, for example, a movie ticket cost on average $2.89. By 2019, the average price of a movie ticket had risen to $9.16. If you saved a $10 bill from 1980, it would buy two fewer movie tickets in 2019 than it would have nearly four decades earlier. 

Don’t think of inflation in terms of higher prices for just one item or service, however. Inflation refers to the broad increase in prices across a sector or an industry, like the automotive or energy business—and ultimately a country’s entire economy. The chief measures of U.S. inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI) and the Personal Consumption Expenditures Price Index (PCE), all of which use varying measures to track the change in prices consumers pay and producers receive in industries across the whole American economy. 

Though it can be frustrating to think about your dollars losing value, most economists consider a small amount of inflation a sign of a healthy economy. A moderate inflation rate encourages you to spend or invest your money today, rather than stuff it under your mattress and watch its value diminish. 

What Causes Inflation? The gradually rising prices associated with inflation can be caused two main ways: demand-pull inflation and cost-push inflation. Both come back to the fundamental economic principles of supply and demand. Demand-pull inflation is when demand for goods or services increases but supply remains the same, pulling up prices. 

For example, at the start of the coronavirus pandemic, the increase in demand for indoor, socially distant activities combined with the highly anticipated release of Animal Crossing: New Horizons saw the price of the Nintendo Switch gaming system almost double on some secondary markets. Because Nintendo could not increase production, due to factory production halts from Covid-19, Nintendo could not raise its supply to meet rising consumer demand, resulting in increasingly higher prices. 

Cost-push inflation is when supply of goods or services is limited in some way but demand remains the same, pushing up prices. Usually, some sort of external event, like a natural disaster, hinders companies’ abilities to produce enough of certain goods to keep up with consumer demand. This allows them to raise prices, resulting in inflation. For example, think about oil prices. You—and pretty much everyone else—need a certain amount of gas to fuel your car. When international treaties or disasters drastically reduce the oil supply, gas prices rise because demand remains relatively stable even as supply shrinks. 

Protect Yourself Against Inflation By: 

• Appropriately investing in your bond portfolio by keeping a relatively short maturity

• Buying Treasury Inflation Protected Securities (TIPS)

• Investing in stocks, which over time have potentially growing dividends and also capital appreciation to protect against inflation

• Consider adding gold and/or commodities as a hedge

• Purchasing real estate whether publicly traded securities or physical real estate

• Fixing any liabilities to the degree possible to get certainty around your future expenses

Incorporating even a few of these steps can help you find a bit more peace of mind about your retirement savings. Inflation is a market force that you cannot control, but with proper planning, it can be accounted for and built into your retirement plan. Give us a call at the office if you want to review your plan and the possibility of higher inflation. 

If you have questions, please contact us.

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