Investing During Periods of Inflation

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What does inflation mean for your investments?

I hope all of you are doing well as we head into the summer of 2021. It has been a whirlwind 15 months, but we are starting to come out of the COVID-19 tunnel. As summer approaches and the economy begins to open up fully, one topic that has garnered plenty of attention is inflation.

One of the goals of retirement, 401(k), and investment planning in the long term is to outpace inflation. It makes sense then that inflation has remained a concern throughout time for investors. It is important for you as an investor and plan participant to understand how inflation works, and impacts your investments.

In August of 2020, the Fed announced it is willing to allow inflation to run higher than normal in order to support the labor market and broader economy. This major policy shift allows inflation to run above the Fed’s 2% goal for some time before the Fed would consider increasing short-term interest rates in an attempt to combat higher prices.1

These robust changes to the Fed’s long-standing inflation policy further illustrates the importance of understanding how inflation is reported and how it can affect your investments.

What is Inflation?

Inflation is defined as an upward movement in the average level of prices. Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index to track these fluctuations. It was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other groups and services.2

How Applicable is the CPI?

While it’s the commonly used indicator of inflation, the CPI has come under scrutiny. For example, the CPI rose 1.4% for the 12-months ending in January 2021 – a relatively small increase. However, a closer look at the report shows movement in prices on a more detailed level. Used car and truck prices, for example, rose 10% during those 12 months. 3

As inflation rises and falls, three notable effects are observed:

First, inflation reduces the real rate of return on investments. So, if an investment earned 6% for a 12-month period, and inflation averaged 1.5% over that time, the investment’s real rate of return would have been 4.5%. If taxes are considered, the real rate of return may be reduced even further.4

Second, inflation puts purchasing power at risk. When prices rise, a fixed amount of money has the power to purchase fewer and fewer goods.

Third, inflation can influence the actions of the Federal Reserve. If the Fed wants to control inflation, it has various methods for reducing the amount of money in circulation. Hypothetically, a smaller supply of money would lead to less spending, which may lead to lower prices and lower inflation.

Empower Yourself with a Trusted Professional

When inflation is low, it’s easy to overlook how rising prices are affecting a household budget. On the other hand, when inflation trends higher, it may be tempting to make more sweeping changes in response to increasing prices. The best approach may be to reach out to your financial professional to help you develop an investment strategy that takes both possible scenarios into account.

As I always say, remember that your financial advisor or plan representative works for you. Never hesitate to reach out to him or her with any questions you may have about your account, retirement plan, or investing in general.

Editor’s note: This material was prepared by MarketingPro, Inc. and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Notes

  1. CNBC.com, August 27, 2020
  2. Bureau of Labor Statistics, 2021
  3. InflationData.com, 2021
  4. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments. Past performance does not guarantee future results.

Article Written By David Wentz and MarketingPro, Inc

David Wentz is CEO of Tax Favored Benefits, Overland Park, Kansas. Wentz is a graduate of the University of Kansas School of Law with a Juris Doctor degree. Wentz frequently speaks at various professional and business seminars about pensions, profit sharing, 401(k) plans, tax favored benefits, and investment programs. Western Equipment Dealers Association endorses Tax Favored Benefits as a 401(k) provider. No compensation is received. More information is available at www.taxfavoredbenefits.com.   

David B. Wentz offers products and services using the following business names: Tax Favored Benefits, Inc. – insurance and financial services | Ameritas Investment Company, LLC (AIC), Member FINRA/SIPC – securities and investments | Ameritas Advisory Services (AAS) – investment advisory services. AIC and AAS are not affiliated with Tax Favored Benefits, Inc. Contact David B. Wentz, J.D., LUTCF, Tax Favored Benefits, Inc., at dbw@tfbusa.com or calling 913/648-5526.

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