Everyone is talking about inflation. You can’t open a newspaper, look at your phone, or go to a barbecue without hearing about it. With all this talk, it can be easy to worry about your financial future. So today we explore the causes of inflation, historical inflation, and what you can do to hedge against this silent tax.
Why does inflation occur?
Inflation is different from market risk: it doesn’t show up in your bank or investment accounts. Instead, inflation presents itself at the gas station and the grocery store, so you do feel it in your pocketbook. Since it eats away at your buying power, inflation is often referred to as retirement’s silent tax.
If you recall your college economics class, you’ll remember that inflation is caused by supply and demand. When there is a limited supply and a high demand, then prices go up. We see that happening now with auto sales due to the offline chip manufacturers and supply chain issues. With inflation, people worry that prices will continue to rise, so they want to rush out and make their purchases now.
Although it is frustrating to see your purchasing power erode so quickly, it’s important to remember, there are worse things that can happen in the economy.
Deflation would be a bigger problem for the economy than inflation. Stagflation is a type of inflation that occurs when prices go up but the economy is slowing and there is high unemployment.
Thankfully, we have the opposite happening now since employers are having a hard time finding workers. Even though it is difficult to watch your purchasing power erode, the other scenarios could be worse.
A historic perspective
The question on everyone’s mind is: will this inflation last? Over the past 10 years, we have had historically low inflation that averaged about 2%. When comparing that average to this past year’s number of 6%, it’s easy to understand why people are concerned.
One way to contemplate the future is by looking at the past. In the 70s, the US experienced some of the highest prolonged inflation rates which were punctuated by the shock in oil supply. After WWI Germany experienced crippling inflation when it had to repay its debts in foreign currency.
The good news about our current situation is the supply chain issues will eventually be resolved. The bad news is higher prices are often the best solution to higher prices. Listen in to see how that works out in the long run.
What should you do to hedge against inflation?
A diversified investment portfolio with global stocks is one way to hedge against inflation and retain buying power down the road. You should also limit the amount of money that you retain in cash, except for withdrawal needs over the next 5-7 years.
TIPS, real estate, commodities, or cryptocurrency are other asset types often discussed as hedges against inflation. But each of these can deal with varying risks of illiquidity, speculation and volatility that could be more challenging to hold in the short-run if the outcome you expect doesn’t materialize.
Whatever you do to protect your wealth, don’t let the media dictate your financial decisions. Stick to your financial plan. If you don’t have a financial plan, reach out to us to see how we can help you weather all kinds of financial storms.
Outline of This Episode
- We have had historically low inflation over the past 10 years [1:52]
- What drives inflation [3:46]
- Why should people care about inflation? [5:45]
- A historic perspective [8:38]
- Investment options to hedge against inflation [13:32]
- Today’s progress principles [20:18]
Resources & People Mentioned
- Episode 139 – Investing for Inflation
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