Inflation is an often misunderstood phenomenon that affects everyone in the economy, from consumers of all ages to the largest corporations. To answer some of the most frequent questions we receive, we will discuss what inflation is, how it’s measured, the causes and effects of inflation, and some strategies to help you manage the impact of inflation on your wallet, retirement savings, or small business.
Inflation is the rate at which the prices of goods and services increase over time. While there are many ways to measure inflation, a couple of the most common are the Consumer Price Index (CPI), which is a basket of goods and services people buy regularly, and the Producer Price Index (PPI), which measures the average change over time realized by domestic producers of goods and services. Just as their names imply, CPI measures inflation (increase or decrease) of prices affecting consumers, and PPI measures price change from the perspective of the seller.
The CPI takes into account things like food, housing, and transportation, as well as services like healthcare, personal care, and education. By tracking the change in the cost of these items, the CPI gives us an idea of how inflation affects the economy. Consumers make up roughly 70% of the economy in the United States, so CPI is viewed as a good measure of overall inflation.
PPI, which takes into account the input costs for businesses, is an indicator of inflationary pressure on businesses. The PPI may also be an indicator of future price increases or decreases for the consumer over time. If producers are paying more to produce goods, they will often pass some or much of these costs to the end user, the consumer.
There are several causes of inflation, including changes in the money supply, changes in the supply and demand of goods, and changes in costs. When the government increases the money supply, it can cause prices to rise, leading to inflation. Similarly, when there’s an increase in demand for certain goods and services, it can also lead to inflation. If supply is limited – as we have seen on items like vehicles and semiconductors recently – prices may also increase due to scarcity of goods or services. On the other hand, increases in costs like wages, taxes, or raw materials can also cause prices to increase as businesses pass along these costs to consumers.
Inflation has many effects on the economy. It can lead to a decrease in the purchasing power of your dollar, meaning the same amount buys fewer goods and services. This can be especially hard on people with low incomes, and/or those on fixed incomes, such as retirees. To maintain their purchasing power, portfolios should be structured accordingly. While not always the case, long-term goals should typically be funded by longer-term assets. These decisions should be discussed with your trusted advisor.
Fortunately, there are some strategies to help you manage the impact of inflation. Most importantly, work with a financial advisor you have confidence in. Taking a realistic approach to finances and budgeting can help you keep track of your spending to minimize overspending. It can also help you identify areas where you can cut back and save money. Another strategy is to invest in assets that can appreciate over time – like stocks and real estate – that may help keep pace with inflation.
Reviewing your portfolio may help identify opportunities to increase income. Being proactive and identifying potential shortfalls may spur ideas to increase your income, such as getting a second job or starting a side business.
Most importantly, by taking a proactive approach to identify potential shortfalls and discuss strategies with a credible advisor, you can help to minimize inflationary risks. If I may be of assistance in any way, please do not hesitate to get in touch.
William (Bill) Parrish is a financial advisor that owns PHP Capital in Littleton, Colorado, and affiliates with Cambridge Investment Research, member FINRA/SIPC. He can be reached at (720) 284-2372 or via email at parrish@phpcapital.com.