Inflation 101 – What to know, what to do
Inflation is perhaps the single-biggest influence on your economic situation. It is not properly understood by many, nor do many people make good decisions in light of it.
Peoples Bank is making the effort to address what may be an important gap in the financial efforts of its customers and others with 4 blog posts. We hope this information is more than instructive, we hope that it is meaningful, helpful. Feel free to write us with your comments, and don’t hesitate to share the link with others.
The first installment define the term and describe it in real-world terms. This one describe what you can do about it (personally) and what tools are available to deal with it. Subsequent blog posts will review how inflation effects bonds and how your retirement can be improved by dealing with it.
How Can You Fight the Effects of Inflation?
Inflation is one of the reasons people – especially those in their 20s and 30s – are often surprised by the amount they will need to save for their retirement. Inflation pushes future costs higher: as a result, the nest egg needed to produce the income you want would need to be bigger.
There are several ways to help combat the ravages of inflation on the value of your savings.
Invest to try to outpace inflation
You should own at least some investments whose potential return exceeds the inflation rate. A portfolio that earns 2% when inflation is 3% actually loses purchasing power each year. Though past performance is no guarantee of future results, stocks historically have provided higher long-term total returns than cash equivalents or bonds. However, that potential for greater returns comes with greater risk of volatility and potential for loss. You can lose part or all of the money you invest in a stock. Because of that volatility, stock investments may not be appropriate for money you count on to be available in the short term. You’ll need to think about whether you have the financial and emotional ability to ride out those ups and downs as you try for greater returns.
Bonds can also help, but since 1926, their inflation-adjusted return has been less than that of stocks. Treasury Inflation Protected Securities (TIPS), backed by the U.S. government, guarantee that your return will keep pace with inflation. The principal is automatically adjusted every six months to reflect increases or decreases in the CPI; as long as you hold a TIPS to maturity, the dollar amount of its principal will never be less than the initial amount.
Diversify your portfolio
Though diversification does not guarantee a profit or ensure against a loss, studies have shown that over the long term, a diversified portfolio typically has outperformed one with only a single asset class. Examples of diversification possibilities include:
- U.S. stocks (growth/value, income-producing, large/midcap/small)
- U.S. bonds (various maturities, taxable/tax-free)
- Real estate (U.S. stocks/REITS, international stocks/REITS, land holdings, commercial real estate)
- Commodities (stocks and commodity futures)precious metals (stocks and bullion)
- International stocks (developed/emerging markets)
- International bonds (varying maturities)
- Alternative investments (private equity, hedge funds, natural resources, and collectibles)
- Cash/cash alternatives (money marketfunds, CDs, money-market accounts)
If you’re saving the same amount each year, you’re not really saving the same amount; you’re saving that dollar figure minus what you’ve lost in purchasing power to inflation. Consider increasing the amount you save each year by at least the rate of inflation if you want to keep a constant savings rate.
Example: For every $1,000 you saved last year, consider saving $1,030 this year ($1,000x the 3% average historical rate of inflation). To continue at that inflation-adjusted rate, you would save $1,061 the following year.
Consider paying off credit card debt
When inflation goes up, interest rates typically do, too. You may suddenly find that purchases not only cost more when you check out; they also cost more over time if you finance them and must pay interest on that amount. Factor interest costs into any credit card purchase, especially if rates are rising.
However, inflation isn’t bad for all debt. If you have a fixed-rate mortgage on your house, the mortgage payments may have seemed huge when you first took out the loan. However, as your income and other expenses increase over time, those payments will probably represent a lower percentage of your costs. Also, because inflation tends to reduce the value of each dollar, payments made 10 years from now would be made in dollars with less buying power.
Installment 1: What Is Inflation and Why Should You Care About It?
Installment 3: Inflation and Bonds: The Ups and Downs.
Contact our Peoples Investment Services, Inc. representative at 828-464-5620 or www.raymondjames.com/PeoplesInvSvcs.
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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013