Understanding inflation is essential to your investment plan. You can learn how inflation will affect your investments using an Inflation Rate Calculator and start making the most lucrative decisions for your investments.
In this guide, we'll break down what you need to know about how to invest with an understanding of inflation. Keep reading before you start investing!
All investors try to foresee the things that will affect the performance of their investments. They make decisions based on what they expect to happen.
Once you can answer how inflation will affect your investments, you'll have better clarity of what to do with your money.
Investing in stocks can help protect your finances from inflation since the profits of a company tend to grow at the same rate that inflation does.
However, the impact of inflation on stocks depends on many factors. Using a calculator can help you make the best financial decision in any given situation.
Inflation is often seen as a bad thing since it reduces consumer purchasing power. However, it's not all bad.
A little bit of inflation shows that the economy is strengthening. Rising wages should offset the costs of inflation for consumers.
Monthly and quarterly, inflation measures get published by the U.S. government. The main measures used are the personal consumption expenditures (PCE) and the Consumer Price Index (CPI) price indexes.
These indexes, over time, perform differently.
Labor Department's Bureau of Labor Statistics (BLS) puts together the CPI each month. This index measures changes in prices for goods and services paid by consumers.
The BLS looks at the spending patterns of wage earners and consumers to compile this information. However, Armed Forces members and rural U.S. residents aren't counted on the list.
The CPI takes a measure of the costs of items purchased on a regular basis. Household surveys weigh items according to their relative importance.
However, some items that get measured, like energy and food, tend to be volatile. When you take away the food and energy measures, you're left with the core CPI.
This is a more accurate measure of the real inflation trend.
Another measure, the Producer Price Index (PPI), measures the same thing but from the point of view of the seller.
The Federal Reserve focuses on keeping employment levels at the maximum and keeping prices stable. The Reserve uses the personal consumption expenditures (PCE) indexes more than the CPI.
The Commerce Department's Bureau of Economic Analysis puts the PCE together. It's seen as a more comprehensive measure because it includes other aspects that the CPI excludes.
In general, the PCE reflects the cost of expenditures made either by households or on behalf of households. Business surveys help determine the weights.
In the CPI index, housing gets weighed more than in the PCE. The PCE, on the other hand, weights the cost of medical care. In both indexes, the costs of energy and food tend to be volatile.
To get the core PCE, again, you have to strip away the energy and food measures. Then, the inflation trend can get measured.
In short, then, inflation measures the rises in how much goods and services cost for consumers. As prices go up, consumers can buy less, and if it rises too high profits decline and the economy slows down.
Because high inflation has a negative impact, the Federal Reserve keeps a close eye on warning signs that hint at a surprise rise in inflation.
Unexpected rises tend to hurt the economy more than expected ones. However, consumers and businesses get used to the new, higher prices.
Rising inflation makes consumers tend not to hold onto cash for as long since its purchasing power value decreases with time. This creates an interesting situation for investors.
While sometimes high inflation is a positive, stimulating the economy and job growth, it can also harm corporate profits.
Each investor has to understand the unique inflation situation and decide what the best move for their money is. Some types of stocks actually do better with high inflation than others.
To understand how inflation affects investments, it's helpful to take a look at the historical returns data for periods of both high and low inflation.
Many studies have taken close looks at how inflation impacts investing. However, when you control for factors like time and geography, the results of these studies seem to conflict.
It seems that expected rises in inflation can cause either positive or negative stock trends. This depends on how well the investor can hedge, as well as the monetary policy of the government.
With unexpected inflation, the findings show that it's more likely to be a positive thing for investors. This could be because unexpected inflation sheds light on what prices are going to do in the future.
Stocks tend to come in two varieties: growth and value.
Value stocks currently have a strong cash flow, but it will slow down with time. Growth stocks, on the other hand, don't have much cash flow now but will grow with time.
When interest rates go up, growth stocks take a bigger hit than value stocks. And interest rates tend to go up to combat rising inflation.
This means that value stocks tend to perform better when inflation goes up than growth stocks do.