HOME
JOIN
CONTACT

Impacts of inflation on your finances

/ NPJ

By Matt Bankston, Shreveport Bossier Journal Columnist

From 1990 to 2020 the average annual inflation rate stood at 2.4%. However, starting in 2021, the annual inflation rate surpassed 5% (Source: U.S. Bureau of Labor Statistics). Wondering if this should raise concern? Let’s delve into the details.

Source: U.S. Bureau of Labor Statistics

The Consumer Price Index

Inflation, denoting a surge in the prices of goods and services, is quantified through the Consumer Price Index (CPI) utilized by the Federal Reserve. This index is derived by evaluating the upward movement in the prices of a basket of goods and services carefully selected to emulate the consumption patterns of the general public. The U.S. Consumer Price Index (CPI) reflects the average variation over time in the prices urban consumers pay for a diverse array of consumer goods and services, encompassing items such as food, clothing, rent, and healthcare.

As consumption habits vary, inflation affects individuals differently, depending on their specific consumption of goods and services.

Historical Trends in Inflation Rates

Historically, the annual inflation rate experienced significant fluctuations. For instance, between 1970 and 1990, it varied widely, averaging 6.90% (Source: U.S. Bureau of Labor Statistics). During this period, the Federal Reserve, as the central banking system of the U.S., implemented various monetary policies to address inflationary pressures and stabilize the economy.

Impacts on Finances

Inflation, by elevating the prices of goods and services, can erode purchasing power if income does not keep pace. The subsequent tables illustrate these impacts numerically.

Price of a $1,000 asset over time based on the annual inflation rate

The above table shows that, for example, at an annual inflation rate of 5% and after 20 years, the price of an asset that was initially $1,000 will rise to $2,653.

Impact of inflation on $5,000 of non-indexed annual income

The above table shows that, for example, with the annual inflation rate at 5% and after 20 years, $50,000 in non-indexed annual income will provide the equivalent of $18,844 in purchasing power.

Purchasing power after having invested $1,000 per year for 25 years

Examining the provided table, it becomes apparent that when the inflation rate aligns with the rate of return, investing merely enables the preservation of your existing purchasing power. Essentially, the return generated serves to counterbalance the impact of inflation on your purchasing ability. However, if your annual rate of return falls below the inflation rate, the purchasing power of your invested money diminishes gradually over time.

Controlling Inflation and Portfolio Impacts

One method employed by the Fed to manage inflation involves adjusting its Fed funds rate. This strategic manipulation aims to find equilibrium between the overall supply of goods and services and the demand for them. Through the modulation of interest rates, the Fed wields influence over borrowing costs, effectively either slowing down or stimulating consumption. When demand recedes due to heightened borrowing costs, prices typically experience a decline. Conversely, higher yields on debt securities can encourage increased consumer investment or savings.

The recent efforts by the Fed to raise the Fed funds rate have undeniably impacted inflation rates. While the first half of 2023 averaged 5.4% , there has been a consistent downward trend in the Consumer Price Index (CPI) each month throughout this year. Starting at 5.6% in January, the October rate showed significant improvement, dropping to 4% (Source: U.S. Bureau of Labor Statistics).This demonstrates a positive trajectory in managing inflationary pressures.

Understanding how inflation is controlled and its potential effects on your portfolio is crucial for navigating these economic dynamics. If you have further questions or need more insights, reach out to a trusted financial advisor.

HOME
JOIN
CONTACT