Inflation is the continuous rise in the price of good and services over time. In the past with dropping interest rates, consumers have more money to spend because of less debt servicing costs. Historically, lower interest rates have often resulted in higher inflation. Many of us might recall the “too much money chasing too few goods,” Econ 101 story growing up, another simple definition of inflation. You can get a good read on inflation by tracking the Consumer Price Index (CPI) and Producer Price Index (PPI). If they are trending up, it usually forecasts inflation.
So what does it all mean?
In essence, if inflation is 2% annually, then $100 would require $102 to buy the same amount of services next year. It decreases your current purchasing power, your money doesn’t go as far.
Another example, might include the price of a $20,000 car in 10 years, because if inflation averaged 5%, the cost would have a projected cost over $32k!!
Inflation increases means that you will buy less with that same amount of money in the future and a fundamental retirement risks. Since we usually budget a set amount of money expenses, if my money doesn’t buy as much, I need to get a way to offset/hedge for this risk.
The Stock Market
When inflation rises suddenly or unexpectedly, it can heighten uncertainty about the economy, leading to lower earnings forecasts for companies and lower stock prices. It costs more to produce the goods or services, effecting profits. It can even possibly have a negative impact on the balance sheet since it could actually drive away sales if it’s too costly. The stock market doesn’t like that but it creates potential volatility in stock prizes.
Traditionally, higher yields means more money moves into bonds, but I recently wrote, To sell or not sell, that with the economy getting back on track, and many blue-chip dividends being higher than potential bonds yields, a huge flight to bonds creating sell pressure probably isn’t realistic.
Pat Moran, managing partner for Healthier Money, specializes in lower risk strategies, protecting against the unexpected and eliminating debt. He can be reached at www.healthiermoney.com