Why is inflation a big deal?
What if you hoped to purchase something in the future but the price kept increasing at a faster rate than what you could save, invest, or afford? That is the concern with high inflation.
Inflation is often defined as the increased cost of goods or services. It’s typical for something to cost more today than it did in the past. A hundred dollars buys less today than it did in the past. Inflation also causes a decrease in purchasing power. As prices increase, the purchasing power of your money decreases. A hundred dollars will likely buy less in the future.
What causes inflation?
Inflation can happen when too many dollars are chasing too few goods or resources. A recent example of this could be stimulus checks and vacation rentals or rental cars. Inflation also happens when prices rise to pay for scarce resources. Think of lumber shortages for homes or computer chips for new cars.
Last week it was reported that U.S. consumer inflation rose 5% year over year in May 2021 as measured by the Consumer Price Index (CPI). This is a large increase that has some worried we could see more inflation.
How serious is it?
Whether small or large, inflation has an impact and all too often people don’t account for it. If you’re saving for your children’s college education, a vacation home, or retirement, today’s dollars may not have the same value as tomorrow’s dollars. Steady growth in inflation (and tax rates) erodes future purchasing power and can make these goals less affordable.
For example, if your investments return 8% but inflation is at 5% then the real return of growth is 3% (not factoring for taxes). Or, if your investment return is 8% and inflation is at 2% then the real return of growth is 6% (again, not factoring for taxes). Inflation (and taxes) can erode the return and ability for you to achieve your goals. Three percent growth or 6% growth produce very different results when trying to plan for the future.
What can you do about it?
Whether the current inflation risks are only short-term or are more prolonged, inflation needs to be considered to realistically plan for your goals and future.
Beyond having an emergency reserve, excess cash in savings accounts can actually lose purchasing power if it isn’t keeping pace with the rate of inflation—and current savings rates are drastically below the current rate of inflation.
If you’re aiming for a long-term goal, it’s important to have your investments responsibly invested for growth. Investing too conservatively may not provide enough of a return to achieve your goals after inflation and taxes. Yes, any investment involves the risk of losing money. When investing too conservatively though, there’s also the risk of not achieving your goals and running out of money.Sojourn well,
Sean M. Williams, CFP®