Is Inflation Haunting Your Financial Dreams? Part 1: What We Know

Has the specter of inflation got you spooked? Recent headlines are filled with sightings. In this two-part series, we’ll look at what to make of all the commentary and what you, as an investor, can do about it. First and foremost, we caution against succumbing to fear or panic in the face of inflation. As usual, careful planning remains your best guide.

What Is Inflation?

Inflation is the rate at which a currency loses its purchasing power as prices increase over time. So, say a cup of coffee cost $1.00 twenty years ago. If the average annual inflation rate had been 2% between then and now, that same pour would cost you $1.49. Various goods, services, and sectors often experience different inflation rates, but general inflation is usually calculated based on the Consumer Price Index (CPI) or a similar broad pricing index.

Recent headlines have reported a noticeable uptick in inflation. Superlatives like “best” and “worst” grab the most attention, so outlets have been abuzz with reports of how a 5% May consumer pricing surge was “the biggest 12-month inflation spike since 2008.”

Putting Inflation in Proper Context

Before you read too much into these recently rising numbers, it’s worth remembering their context. We’re comparing May 2021 to May 2020, when we were still deep into what The Wall Street Journal called a “screwy” pandemic economy. The WSJ explained, “If a company takes a hit in one year and then gets back to normal the next, it can look like its profits are soaring when in fact, they are just getting back on track.”

The Federal Reserve’s 10 Year Break-Even Inflation Rate is one common estimate of the market’s expected average annual inflation rate for the next 10 years. As of mid-June, that rate stood at 2.3%. That’s up from the lower 1.2% rate expectation from mid-June 2020, but it’s still not eye-popping.

This leads to another important point: Not all inflation is bad. A bit of inflation goes hand in hand with economic growth and reasonable interest rates for lenders and borrowers alike. A 2% annual inflation rate is typically considered a desirable norm for greasing the wheels of commerce without destroying the working relationship between currencies and costs.

What if Inflation Runs Amok?

While inflation has its purposes, it’s troubling if it goes on a rampage. When it does, uncertainty spikes as well, wreaking havoc on commerce, the economy, job markets, real estate, and financial markets. (Deflation—the opposite of inflation—can also upset the economy if prices drop too precipitously.)

Investors who were around in the 1970s may remember the last time the U.S. experienced red-hot inflation and what it felt like when it spiked to a feverish 14.8% in 1980 .

The New York Times described it as an era when “prices of real assets like houses, gold, and oil soared. Average mortgage rates exceeded 17%, and interest rates on bank certificates of deposit approached 12%. It was hard to know whether a 5% pay raise was cause for celebration or despair.” While 12% CD rates may sound great, when interest and inflation rates are comparable, the real returns from even high-interest CDs essentially become a wash.

After the 1980 high-water mark, the Volcker-era Federal Reserve tamped inflation back down. So younger investors have heard of, but never experienced, such steep inflation for such an extended time. Despite occasional alarm bells, inflation has mostly continued to hit the snooze button for decades. At least so far.

Next Up: What Can You Do About It?

What if inflation does get out of hand and stays that way for a while? Depending on who you heed, the possibility ranges from unexpected, to possible, to a near certainty. In our next piece, we’ll cover why forecasts remain as fuzzy as ever and how investors can best prepare for whatever may happen next. As usual, prudent financial planning is preferable to making hasty decisions.

About Eric

Erickson Braund is the Founder and Chief Financial Officer at Black Walnut Wealth Management. He is a Certified Financial Planner®️ professional and a Chartered Retirement Planning Counselor®️. Eric brings over 20 years of experience working with high net-worth individuals and families, helping them achieve their goals of protecting and growing their wealth for retirement and for generations to come. Because Eric is a CFP®️ professional, he adheres to high ethical standards and engages in at least 30 hours of approved continuing education in the financial industry each year.

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