It’s no secret that the prices of everyday purchases are rising quickly due to strong consumer demand and supply chain problems. Not only does this impact consumers’ wallets but it also has wide-ranging implications for investment portfolios. However, it’s important to keep inflation, consumer sentiment, and the overall growth of the market in perspective when making long-term financial decisions. After all, some of the same factors that have pushed up the prices of goods have also affected stock prices, home values and more.
Prices have increased significantly in the last year
In January 2022, the Consumer Price Index (CPI) rose by 7.5% over the previous year, the fastest pace since 1982. This was fueled by:
- the rising prices of everyday necessities like food and energy (which rose 7% and 27%, respectively).
- supply chain disruptions, which continued to affect other major categories, most notably vehicle prices (which rose 12.2% for new cars and 40.5% for used ones).
Other recent economic data shows that the prices charged by producers rose 9.7% year-on-year.
How inflation can affect your everyday life
Inflation affects our everyday lives in several ways and, naturally, this disproportionately hurts consumers who have tight budgets or who are in or near retirement. However, it also affects those who do not have diversified investments.
Chart: Inflation is at its highest level in 40 years. This erodes the value of cash and savings over time. Holding an appropriate investment portfolio can help offset this risk.
Sources: Clearnomics, FDIC. For illustrative purposes only
Diversification is more important than ever
All this underscores the need to hold an appropriately diversified portfolio designed to offset rising expenses and protect savings and wealth. Specifically, this means being aware of spending requirements relative to portfolio yield and other sources of income. The average savings account or certificate of deposit not only isn’t keeping up, but its value can be quietly eroded over time.
This highlights the benefits of holding other types of financial assets. For instance, many areas of the stock market can benefit as companies increase their prices. Thus, inflation can be a double-edged sword which can hurt consumers but help investors. If sales and earnings growth remain steady, history shows that the stock market and investment portfolios can benefit over time.
This could be why, despite the hit to pocketbooks, household net worth in the U.S. is at a record of nearly $145 trillion. This can also create a “wealth effect” that supports long-term consumer spending beyond the initial recovery. Thus, it’s important to consider the full consumer income statement and balance sheet when evaluating the impact of inflation.
Thus, as always, it’s best to hold a portfolio that can withstand different economic conditions in order to stay on track to achieve long-term financial goals.
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