What is inflation?

Understanding inflation is key to investing given its potential impact on the value of investment returns and future spending ability.

Inflation refers to the increase in the cost of goods and services of an economy. Various factors cause inflation, but they can be placed into two overarching categories: demand-pull and cost-push.

Demand-pull is when consumer demand exceeds the supply of that good or service.¹ This is usually indicative of a good economy or increased consumer spending.

Cost-push is typically experienced when the price of labor or materials increases, causing the price of goods and services to rise.¹

Consumer spending habits may be impacted during times of higher inflation. For example, when grocery shopping you may notice increased prices, making you consider what you need versus what you want.

When inflation increases, purchasing power is reduced. How can you make sure your income today will cover your retirement expenses?² During times of high inflation, it may be prudent to revisit your budget and financial strategy. A financial professional may be able to help you identify how to mitigate the impact of inflation on your retirement strategy.²

Inflation may also have a negative effect on your investments. Stocks may be negatively affected by periods of high inflation, as the stock market may be more volatile.³ However, investing in equities may help you outpace inflation long-term. Investing during a period of low stock prices may result in gains, as periods of decline are often followed by periods of positive returns.⁴

A high inflation rate commonly results in rising interest rates, which generally has a negative effect on bond prices.⁵ Typically, bonds with longer duration will be impacted more negatively than those with a shorter duration. However, some bonds have features that protect them against inflation, the most common being Treasury Inflation Protected Securities (TIPS). TIPS feature a fixed interest rate until maturity and the principal amount is adjusted for inflation, meaning the coupon payment received varies with inflation.⁶ Another feature of TIPS is that the principal amount of the bonds are protected.⁶ At maturity, you will receive the higher, inflation-adjusted principal amount, or the original principal amount agreed to at the time of issuance, but never less. Talk to your financial professional about what inflation-protected products may be beneficial to your portfolio.

Speak to a financial professional about inflation and how they may be able to help you combat the impact of inflation in your everyday life.

*Consumer Price Index measures the average change in prices overtime for goods and services. CPI is one of the most popular measures for inflation.