Rising Inflation: Should You Be Worried?

For the first time in two generations, prevailing prices in the United States are rising at a rate that can be felt each time we make a purchase. In June 2022, prices rose 9.1% over the previous year as measured by the Consumer Price Index (CPI). It has been over 40 years since we last saw inflation approach double digits.

To put this into perspective, inflation over the past 20 years, from 2001 to 2021, averaged a healthy 2.2%. Let’s compare this to one of the worst 20-year inflationary periods from 1968 to 1988, which averaged 6.4%. The value of $100 at the beginning of these periods would buy $63 in 2021 and a meager $25 in 1988. This is a whopping 75% reduction in purchasing power over 20 short years.

You may be wondering if you can protect against inflation in the short run. The answer to that question is yes. But first, let’s examine the major inflation number we often hear in the headlines, the CPI. This includes 80,000 goods and services ranging from childcare to gasoline. However, most Americans only buy a few of these items to maintain their lifestyle.

Let’s look at an example. According to The Wall Street Journal’s inflation tracker, a cup of coffee in June 2022 cost you about 16% more than it did a year ago. On the other hand, a glass of wine only increased by about 2% in a similar timeframe. Those who purchase coffee experienced much higher inflation than those who purchase wine. We see similar examples among the many different products we buy regularly. In other words, your spending pattern is the primary driver of how you experience inflation.

Inflation is especially harmful for households that spend a large percentage of their income and savings to live. For those who manage to live on a smaller percentage, the impact of inflation is less detrimental. That is because more dollars can be invested to build wealth and stay ahead of rising prices.

How can you stack the odds in your favor?

Let’s go back to our 20-year timeframe from 1968 to 1988. Say you stuffed $1 million underneath your mattress at the beginning of this period; it would have the purchasing power of a meager $254,724 two decades later.

Alternatively, let’s say you invested your $1 million in the S&P 500 and similarly reinvested the earnings; the 20-year period ending in 1988 saw an average annual return of 10.56%. Your initial investment would have grown to $6,866,965. Adjusted for inflation, this would be worth roughly $1,904,000—not bad given the highest inflationary period in modern U.S. history.

Properly investing your dollars in equities is one of the best tools available to protect purchasing power. The key is to focus on the long-term. Equities typically require a few business cycles to be effective against inflation.

Protecting your purchasing power 

In the short run, it is difficult to protect against the erosion of your dollars. Today, safe assets considered “risk-free,” such as the 10-year treasury, are yielding investors interest payments in the low single digits, a losing proposition when compared to the inflation rate.

What about Treasury Inflation-Protected Securities (TIPS)? These are bonds issued by the U.S. government that pay investors interest indexed to the inflation rate. In theory, these should be adequate, but unfortunately, they are susceptible to losses depending on inflation expectations and interest rates.

When can we expect inflation to normalize?

It is impossible to predict when prices will stabilize. While no one has a crystal ball, we can look at history for guidance.

The onset of the COVID-19 pandemic led to unexpected dynamics as many Americans stayed home. Demand across the economy fell, supply chains broke, and many Americans saved cash with a tailwind of fiscal stimulus. As COVID restrictions lifted, pent-up demand rose sharply, sending supply chains scrambling. This sent prices trending upwards. 

Before COVID, the U.S. experienced six episodes of heightened inflation since World War II, when CPI rose above 5%. The most recent three came in the late 1960s through the early 1980s, the early 1990s, and a brief stint in 2008, all of which were characterized by oil shocks. Unlike in previous periods, the U.S. is now one of the world’s top oil producers, making prolonged oil shock less likely.

The inflation we see in 2022 is more akin to the episode shortly after World War II from 1946–1948. Supply chains strained to shift from war to commercial production. Meanwhile, pent-up demand from prospering American consumers caused prices to climb drastically. Some experts estimate this inflationary episode lasted two years while supply chains caught up and demand normalized.

Evidence suggests we’ll experience a shorter period of heightened inflation analogous to the mid-1940s, but price trends similar to the prolonged inflation of the late 1960s through the early 1980s are not entirely out of the question. 

What can you control?

Staying properly invested through bad times can often be difficult, whether it’s high inflation or declining equity markets (or both). In our view, prudent exposure to equities remains one of the best hedges against inflation and a remarkable tool for building long-term wealth. Best of all, you have ultimate control of your allocation to equities.

Your Resource Consulting Group team is happy to answer any questions regarding inflation in the context of your overall goals and objectives.