Inflation is on the minds of investors as February 2021 comes to a close. As you can see in the chart below, inflation expectations have risen sharply from the COVID lows to the highest level since 2013*. Of course, this is “expected” inflation over the next five years and not actual inflation which is currently 1.37%**, according to the Federal Reserve’s measure of the Consumer Price Index (CPI). This means that traders and investors are expecting the CPI to increase significantly over the next five years.
With the prospect of rising inflation over the next few years its important to ask – how might inflation hurt me?
Inflation hurts you by reducing the value of the dollars you have. If you have a large chunk of money in savings earning next to nothing, then the purchasing power of that money is declining each year. If the cost of goods rises faster that your salary then you will be worse off than the year before. If you have a fixed pension payout in retirement but your expenses are rising due to inflation then it will take more dollars to purchase the same amount of goods each year.
In the investing world, inflation hurts bonds with fixed payments. The majority of bonds promise to return your principal at the end of the bond’s term along with an interest payment each year (typically semi-annual). The value of both the principal payment and the interest payments are now worth less due to rising inflation, so the price of the bond needs to decrease to reflect the decrease in the value of the cash flows to the bond holder.
Are there any good aspects to inflation?
Its not all bad news with inflation. If you are a debtor making fixed payments on a loan then inflation works in your favor. If your income is increasing with inflation then the fixed payments you are making on your debt become a smaller percentage of your expenditures. You are essentially paying back the loan with money that is worth less each year.
There are a number of investments that have historically performed well when inflation picks up. The chart below, although from a narrow time frame, gives you a decent idea of the asset classes that have performed well historically during periods of rising inflation. Owning some of these assets may help your portfolio keep pace or even beat the inflation rate over time.
The word “bogeyman” comes after the word “inflation” a lot because it’s a complicated and scary monetary phenomenon that few people understand. To wrap your head around what inflation means for your financial goals, try completing a financial plan with a CERTIFIED FINANCIAL PLANNER™️. The financial planning program that I use runs a “stress test” on each clients financial plan which includes inflation increasing significantly over the life of the plan. If a pickup in inflation puts the client’s financial goals at risk, then I work with the client to implement strategies that can protect against that risk. Your financial situation is unique to you so it’s important to know how inflation affects your financial life.
Charles Brown is a CERTIFIED FINANCIAL PLANNER™️ and Portfolio Manager at M. Brown Financial Advisors in Naperville, Illinois.
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*Chart as of 2/25/2021 – thanks to @CharlieBilello for the chart – Breakeven inflation rate is the rate of inflation at which investors in Treasury Inflation Protected Securities will “breakeven” if the security is held for the next five years.
**https://fred.stlouisfed.org/graph/?g=8dGq as of January 2021
***The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
****Securities and Investment Advisory services offered through Ausdal Financial Partners, Inc, 5187 Utica Ridge Road, Davenport, IA 52807 (563)326-2064. Member: FINRA/SIPC. M.Brown and Associates / M. Brown Financial Advisors and Ausdal Financial Partners are independently owned and operated.