Matt's Money: Inflamation and your money
The Bureau of Labor Statistics (BLS) tell us that CPI (Consumer Price Index) is currently at an annualized rate of 2.25 percent as of October 2018. So why do your bills seem like they're going up at a much faster rate than that?
The short answer is how the government defines and measures inflation. It simply doesn’t measure the same way for everyone.
Inflation is defined as an upward movement in the average level of prices. Each month, the Bureau of Labor Statistics reports on the average level of prices when it releases the Consumer Price Index (CPI). The CPI is a measure of the change in the prices for a “market basket” of consumer goods and services over a period of time.
The CPI is developed from detailed expenditure information provided by families and individuals on what they actually bought in eight major categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other groups and services.
Many find that the government’s “basket” doesn’t reflect their experience, so the CPI, while an indicator of the rate of inflation, has come under some scrutiny. For example, while CPI rose 2.89% for the 12-months ending July 2018, gasoline prices rose 9% for that same 12 months period, according the same BLS report.
What’s more important is how we all plan for inflation because it’s going to happen.
First, inflation reduces the real rate of return on your investments. If an investment earned 6% for a 12-month period, and inflation averaged 1.5% over that time, the investment’s real rate of return would have been 4.5%. If taxes are considered, the real rate of return may be reduced further.
Second, inflation puts purchasing power at risk. When prices rise, a fixed amount of money has the power to purchase fewer and fewer goods. Cash alternatives — which earn a low rate of return — may not be able to keep pace with the rise in prices.
Third, inflation can influence the actions of the Federal Reserve. If the Fed wants to control inflation, it has various methods for reducing the amount of money in circulation. In theory, a smaller supply of money would lead to less spending. And that, in turn, may lead to lower prices and lower inflation.
When inflation is low, it’s easy to overlook how rising prices are affecting a household budget.
On the other hand, when inflation is high, it may be tempting to make more sweeping changes in response to increasing prices.
The best approach may be to develop a sound investment strategy that takes both possible scenarios into account.
Securities offered through Royal Alliance Associates, Inc. Member FINRA, SIPC. Advisory services offered through Matt Montgomery, a Registered Investment Advisor not affiliated with Royal Alliance Associates, Inc., 1504 East Rusk, Jacksonville, Texas, 903-586-3494. * An Index is a portfolio of specific securities (common examples are S&P, DJIA, NASDAQ), the performance of which is used as a benchmark in judging the relative performance of certain asset classes. Indexes are un-managed portfolios and investors cannot invest directly in an index. Past performance is not indicative of future results.
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