Inflation seems to infiltrate newsfeeds this year as prices have noticeably risen. While it is a notable concern, let’s dive into understanding some of the basic influences and definitions of inflation and how it affects personal finances.
Inflation is a seemingly invisible force that causes prices to rise over time. Alternatively, inflation is really seen as the purchasing power of the dollar decreasing. In other words, what a dollar is worth today, will be worth less later. Syndrome from Disney’s Incredibles said, “When everyone’s super, no one will be.” Applying that same theme to the economy, when too much money is printed and spread around, it diminishes its value.
A plethora of factors increases the inflation rate. Just a few recent examples are the supply chain issues due to COVID-19 pressures, the increase in American currency circulation in the last few years, and the stimulus money many individuals and businesses received. Inflation has been around for a long time, but with the recent spike, many have started sharing memes that compare “average incomes” with “average home prices” over time. Saving those inaccurate averages for another day, let’s look at something most of us know and can put our finger on: The Big Mac.
The Big Mac & Why You Shouldn’t Compare Prices without Context
The Big Mac sandwich launched its appearance in 1967, with a price tag of just 45 cents. By the 1980s, the price had more than tripled to $1.60 and by the 1990s, it was sitting at $2.45. Today, we’re nearing $5 for a Big Mac.
While this simple list of prices could look alarming, we should consider the costs involved over the 55 years—the globalization of the economy during this time, the technology boom at the turn of the century, and the multiple generations of people born during this time entering and exiting the workforce to name a few. To try to understand and compare the complexity of the economic situation is an extensive feat. This reinforces the idea that comparing prices without context is spreading seeds of miscommunication.
Let’s jump back out of the weeds to look back to simple economic terms of supply and demand. The value of the good is determined by the demand for that good, with how much of the supply of that good is available. When a business has an overstock of items in inventory and low demand for those products, it usually sparks a sale or discount in price. What we have seen with the supply chain is a reduced amount of supply which in turn, drives the price higher.
How does raising interest rates impact inflation?
The Fed rate raises the cost of borrowing by increasing an interest rate. That rate then trickles down to other lenders, increasing the cost of borrowing. This is typically referred to as the “tightening money” policy. By increasing the cost to borrow, it becomes less attractive to borrow and trends will show that less demand for borrowing typically reduces inflationary pressures of goods. It merely slows the economy enough to recover from the extensive growth spurt experienced in 2021.
Here’s an analogy for borrowing at low or high rates. When you go to the grocery store, typically parking spots closest to the storefront are occupied, and it’s hard to find an available spot near the door. There are just as many spots in the back half of the lot as in the front half. Even though the spots are the same, the distance to walk is further. It’s still a parking space, with all the perks of having a spot for your car, but you’ll have to walk further.
When rates are low, and the cost to borrow is low, more people jump at the chance to borrow; however, as the cost to borrow increases, fewer people will take it. This process has typically fought inflation because people reallocate their money to other places in the market thus driving the demand for goods and services down.
How does inflation impact my portfolio?
One of the primary concerns people are facing is higher prices, and their portfolios lower, for 2022. This is a valid concern, especially for those in or approaching retirement. Inflation’s impact on prices has been observed in portfolios. The two primary culprits in this scenario are the bond market and the growth sectors of the stock market.
While extensive research contributes to these markets individually for their movements, let’s take another basic look from a macro side. For the bond market, the price of the bond has the inverse reaction to the Fed rate. If the rate rises, the price falls. Inside the portfolio, the performance is based on those prices, and one of the major impacts on a balanced portfolio this year.
However, what is essentially missing from that return number is the other factor of bonds. Bonds are essentially a loan that you give a company or the government, and in turn, interest or a coupon is attached to that loan/bond amount. That interest rate trickles down from the Fed rate, giving a higher coupon. Even though the price has decreased, interest income is increasing.
Different in 2022, is how drastically this inflation period hit the bond market because bonds have historically been viewed as a safety holding in portfolios. This is due to the interest income collected; however, this drastic change in the balanced portfolio in combination with increased inflation is one of the most painful points of this year. This can signal investors to seek other opportunities with their portfolio, like alternatives, to leverage additional returns and pursue non-correlated risks.
Beyond the bond market, we have also witnessed the growth stocks take a huge hit this year. Similar to bonds, the bond rates matter to growth companies. Growth companies typically borrow to grow their businesses. Borrowing, as we’ve learned, costs more as the rates are increasing. Add the inflated prices of goods and wages, and we just break the surface of how company income statements are impacted.
Seeking “safety” is on most people’s radars these days, and while easy solutions are hard to find, now is a great time to speak with a financial professional.
How can Anthem help me with this what if?
We are here to help you understand what’s happening in the market. Reminding you of your short- and long-term goals and helping you plan for retirement. We remind you to focus on your future and not stress about the present as we continue to manage the investment for the long term. We suggest invested accounts are for long-term investing. While inflation in the near term can negatively impact your spending plan, we incorporate inflation in your planning for retirement, to ensure it is accommodated for.
Our portfolios are built with a long-term focus in mind. We also use tactical management to adjust the allocation in the short term to mitigate risk and take advantage of opportunities. According to your level of risk, we strategize with you individually to check on your long-term goals and plans.
Additionally, we offer a “strategic alternatives” allocation in our portfolios. We utilize these to help shift some of the weight of typical stock and bond portfolios with non-correlated assets, for further diversification. Unsure if Strategic Alternatives is a fit for you? Schedule a call with us today.
We’re Here to Help
If you want to discuss these or other “What if?” financial questions you have, please contact us: anthem@oneascent.com or 256.288.0192
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** Past performance may not be representative of future results. All investments are subject to loss. Forecasts regarding the market or economy are subject to a wide range of possible outcomes. The views presented in this market update may prove to be inaccurate for a variety of factors. These views are as of the date listed above and are subject to change based on changes in fundamental economic or market-related data. Please contact your Financial Advisor in order to complete an updated risk assessment to ensure that your investment allocation is appropriate.