Investors Should Account for Rising Inflation

As an investor, you would be well served to understand the latest Consumer Price Index data from the Department of Labor. This is because all the massive trillion-dollar stimulus packages will have inflationary implications one way or another. And inflation will impact your long-term retirement strategies.

Inflation Matters

In simple terms, inflation is defined as an increase in the general level of prices for goods and services. Deflation, on the other hand, is defined as a decrease in the general level of prices for goods and services. It matters because inflation decreases the purchasing power of your money in the future. If inflation is 10% (which is considered high), then a loaf of bread that costs $1.00 this year will cost $1.10 the next year.

Inflation in the U.S. has averaged around 3.3% from 1914 until 2019 and it has averaged about 3.7% for the past 60 years. The annual inflation rate for 2019 came in at 2.3%, its largest annual rate since 2011.

Watching Inflation

The U.S. Department of Labor Bureau of Labor Statistics publishes monthly measures of inflation when it calculates the Consumer Price Index (CPI).

The last time we saw a substantial decrease in the CPI was more than a year ago. In May 2020, it was reported that the Consumer Price Index for All Urban Consumers declined 0.8% in April, the largest monthly decline since December 2008.

The reasons for the large change were identified as follows:

• A 20.6% decline in the gasoline index was the largest contributor to the monthly decrease
• The indices for apparel, motor vehicle insurance, airline fares, and lodging away from home all fell sharply as well

Interestingly, the Food indices actually rose in April 2020, with the index for food at home posting its largest monthly increase since February 1974. Otherwise, April’s CPI decrease would have been larger. But more importantly, the CPI for all items minus food and energy fell 0.4% in April 2020, the largest monthly decline in the history of the series, which dates to 1957.

Since May 2020, monthly CPI numbers have almost exclusively shown we are in an inflationary period, with the largest reported increase in June, at 0.9%. 

Accounting for 3% Inflation

Investors to think about whether inflation will find its way into the broad economy, given all the money that government stimulus created. And more importantly, what should an investor do about it?

While no simple answer covers every situation, generally speaking, your long-term retirement strategies should account for inflation. And a good rule of thumb is that you assume inflation to be about 3% – its historical average.

If you’re wrong and we find that the inflation rate for the next 25 years turns out to be less than your assumed 3%, then the purchasing power of your retirement savings will be more, not less.

Your financial advisor can help model different retirement scenarios while accounting for inflation.