Thinking about Inflation over Time
Updated: Mar 14
In our most recent newsletter, we discussed the recent uptick in inflation, as measured in the US economy by the Consumer Price Index (CPI). Our principal focus was on the way that most equity (stock) investments have tended to grow at a faster rate than inflation over time. This, we pointed out, is a good thing for investors who want to make sure that that the purchasing power of their investments continues to keep pace with the ever-rising cost of goods and services.
At a current rate of 6.22%, US inflation has increased steadily as the economy has continued its recovery from the 2020 shocks imposed by the pandemic, during which the rate was running well below 2% (in May 2020, at its lowest point, the rate was 0.12%). As inflation has increased, investors have become concerned, since out-of-control inflation can wreck an economy and the businesses that operate within it. More recently, the stock market seems to have shrugged off inflation worries—at least temporarily—closing at or near all-time highs in recent weeks.
Nevertheless, inflation will probably continue to be in the news for some time, as the economy continues to expand and especially as supply-chain tangles maintain upward pressure on the cost of obtaining critical goods. So, it seems important to step back and take a long-term view of inflation and its effects, especially as they relate to individual consumers and investors.
At its most basic, the effect of inflation on individuals is the loss of purchasing power. While this happens incrementally, inflation can nevertheless cause real damage over the long haul, as the value of that dollar in your pocket slowly, invisibly erodes to a point that would be impossible to imagine without looking at historical price shifts. Consider that in 1950, the average American home could be purchased for $7,354. A brand-new Volkswagen Beetle was selling for $1,280, and annual tuition at the Ivy League University of Pennsylvania was $600. You could buy a cup of coffee for a nickel, and a gallon of gas cost 27 cents. A loaf of bread would set you back 19 cents, first-class postage stamps cost three cents, and you could buy a McDonald’s hamburger for 15 cents, while ten cents more would get you either fries or a soda. The average movie ticket cost about 40 cents, a dime got you a ride on the New York City subway and bleacher tickets to the 1950 Major League Baseball All-Star game cost $1.
What kind of insane inflation rate produced such an amazing (and depressing) erosion in the value of that 1950s dollar? The inflation rate between 1950 and today has averaged 3.46% per year—just over half the present annual rate.
The quiet, yet persistent ability of inflation to rob you of purchasing power is why we often refer to it as “the silent thief.” Some inflation is inevitable in a healthy economy, but as long as it is there, it is decreasing the value of the money you spend to buy the goods and services you need. Inflation must be carefully observed and controlled, to the extent possible, which is why the Federal Reserve recently announced plans to begin curtailing its purchases of US Treasury bonds. By doing this, the Fed intends to reduce the amount of liquidity in the economy and dampen the inflationary effect of too much currency chasing too few goods.
For the individual investor, it is vital to consider both the constant presence of inflation and its long-term effects on purchasing power. Any portfolio that does not generate sufficient growth to keep pace with inflation over time is effectively shrinking: placing the investor at greater risk of running out of sufficient assets to maintain a desired lifestyle.
At Bernhardt Wealth Management, our central aim as fiduciary, fee-only advisors is to guide our clients toward making decisions that will best serve their interests, whether those include ensuring a comfortable, stress-free retirement, providing financial security for future generations, or funding the charitable and philanthropic causes that are most important to them. If you have questions about any aspect of your investment portfolio or financial planning strategy, please contact us.