Inflation and Your Money

Terry Allen, CFP®, AWMA

August 07, 2024

In June 2024, the inflation rate was reported as 3%. ⁽¹⁾ You may be asking yourself,” then why do my bills seem like they're at least 10 percent higher than last year?"

You are not the only one asking that question, and it illustrates the importance of understanding how inflation is reported and how it can affect spending and investments.

In 2023, the average rate of inflation was 4.1%.
In 2022, the average rate of inflation was 8.0%.
In 2021, the average rate of inflation was 4.7%.
In 2020, the average rate of inflation was 1.2%. ⁽¹⁾

What Is Inflation?

Inflation is defined as an upward movement in the average level of prices. Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) to track these fluctuations. It was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other groups and services. ⁽²⁾

How Applicable Is the CPI?

While it is the commonly used indicator of inflation, the CPI has come under scrutiny. For example, the CPI rose 7.9 percent for the 12 months ending in February 2022. However, a closer look at the report shows movement in prices on a more detailed level. Energy prices, for example, rose 25.6 percent during those 12 months.⁽³⁾

Are Investments Affected by Inflation?

They sure are. As inflation rises and falls, three notable effects are observed.

First, inflation reduces the real rate of return on investments. So, if an investment earned 6 percent for a 12-month period and inflation averaged 1.5 percent over that time, the investment's real rate of return would have been 4.5 percent. If taxes are considered, the real rate of return may be reduced even further.⁽⁴⁾

Second, inflation puts purchasing power at risk. When prices rise, a fixed amount of money has the power to purchase fewer and fewer goods. A trip to the grocery store, gas station or even your local McDonald’s is a painful reminder of this. The price of a Big Mac has increased 70% over the last ten years.⁽⁵⁾The Federal Reserve aims for a 2% inflation rate. When households and businesses can reasonably expect inflation to remain low and stable, they are able to make sound decisions regarding saving, borrowing, and investment, which contributes to a well-functioning economy. ⁽⁶⁾

Third, inflation can influence the actions of the Federal Reserve. If the Fed wants to control inflation, it has various methods for reducing the amount of money in circulation. Hypothetically, a smaller supply of money would lead to less spending, which may lead to lower prices and lower inflation.

Empower Yourself with Trusted Guidance and Support

When inflation is low, it's easy to overlook how rising prices are affecting a household budget. On the other hand, when inflation is high, as it has been in the last few years, it may be tempting to make more sweeping changes in response to increasing prices. The best approach may be to reach out to me so that we can work together to develop a sound investment strategy that takes both possible scenarios into account.

I enjoy working with my clients, navigating economic challenges to maintain the financially independent lives they have built for themselves. And, if you are not currently a client, I would appreciate the opportunity to do the same for you.