Inflation and your financial health: what you should know
Did you know the annualized inflation rate in the United States is currently at 6.2%, the highest it has been since November 1990? In the meantime, a recent Bankrate survey put the national average interest rate for savings accounts at just 0.06%.
When inflation is higher than the interest rates of your bonds and savings, your purchasing power goes down over time. Your Oakwell experts are here to help you stay informed about inflation and keep your finances healthy.
How inflation affects your financial health
While you should always keep inflation in mind, you especially need to pay attention to it right now as the economy continues to adjust to unrest from the COVID-19 pandemic.
What inflation can cost you
After the pandemic caused a period of slow economic activity, many businesses are now “reporting strong demand for goods and services” of all kinds. This change is causing the costs of those goods and services to rise, sometimes substantially.
One statistic commonly used to measure inflation in the U.S. is the Consumer Price Index. It essentially describes price changes from the consumer’s point of view. Think about it like this: what can you buy with one dollar today? Fifty years ago, that dollar could have bought you much more.
To put it in perspective, check out this article by The Daily Meal to see what a dollar could buy you in each year since 1937 and compare each item to the cost of the same item today. For example, a dollar in 1941 could have bought you three pounds of top sirloin. In comparison, Statista reported the 2020 retail price for a single pound of sirloin steak in the U.S. averaged almost nine dollars.
Not only are the costs of goods and living on the rise, but business owners are also experiencing higher costs for inventory, labor, and other business expenses. Overall, a high inflation rate can literally cost you a significant amount, whether you are a consumer or a business owner.
Inflation and your savings
As inflation causes costs to rise, it also cuts into your purchasing power. To put it another way: a dollar can buy you less today than it could ten years ago, but it’s also worth less than that same dollar ten years ago.
A high inflation rate combined with low interest rates translates to negative interest for your funds. Investopedia uses the following example to show how inflation affects your cash savings:
“Let’s say you have $100 in a savings account that pays a 1% interest rate. After a year, you will have $101 in your account. But if the rate of inflation is running at 2%, you would need $102 to have the same buying power that you started with.”
Even though you have gained a dollar in interest, your buying power has decreased. You lose money if your savings rate does not equal or surpass the rate of inflation.
How you can stay ahead of inflation
A thorough financial plan can help you stay ahead of inflation with portfolios primarily composed of stock and real estate investments. The stock market can sometimes be volatile or challenging to predict, but you tend to outpace inflation over time.
This chart shared by Avantis Investors compares the changes in the purchasing power of one dollar in cash, treasury bills, commercial paper, and stocks. While a short-term view of the U.S. stock market might make it seem risky, this longer-term perspective shows that investing is the clear winner when it comes to increasing your purchasing power over time.
If you plan on investing, it is crucial to keep your risk profile and time horizon in mind to find an asset allocation that works for your specific circumstances. Staying invested over a longer term, embracing diversification, and leveraging tax- and cost-efficient strategies can all help you achieve positive returns and, ultimately, outpace inflation.
The “long and short” of inflation
Looking long-term at inflation, remember that inflation considerations should always be considered in solid financial plans. The Oakwell investment committee considers many factors, balancing positive and negative information to anticipate the consequences of concerns such as government spending, emerging technologies, international relations, and more.
In the short term, it is likely that some of the recent concern surrounding inflation is not permanent. The market is equipped to handle the expected consequences of issues such as those we have been experiencing because of the pandemic: supply chain issues, unemployment, and more.
Since the height of the pandemic, we have seen tremendous economic growth. As Avantis Investors put it, “pent-up demand for goods and services has strained supply chains and triggered this higher-than-expected “transitory” inflation that many economists expect to be brief.”
Here are the most important things you should understand about inflation:
- You are not keeping up with inflation if:
- Your investments are focused on fixed income or bonds, OR…
- You have a strong cash position or primarily cash savings accounts
- Inflation costs you over time by:
- Increasing the costs of goods, services, and business expenses
- Decreasing the purchasing power of your savings
- If you want to increase your purchasing power:
- Stay invested in stocks over a longer term
- Embrace diversification while keeping your risk profile and time horizon in mind
Your Oakwell Private Wealth Management experts can leverage tax- and cost-efficient strategies to help you outpace inflation and maintain your financial health. Get in touch with us today to discuss how we can help you establish or adjust a strong financial plan that keeps the small details and the bigger picture in mind.
The information contained in this article represents the opinion of Oakwell Private Wealth Management and should not be construed as personalized or individualized investment advice.