Understanding Inflation



When it comes to the economy and investing for the future, inflation is a much talked about, but often misunderstood, subject. Kyle Jones, Financial Planner with Wamhoff Financial Planning & Accounting, shares information to help explain what you need to know about inflation.

  1. What is inflation?
    • The rate at which the general level of prices for goods and services is rising, while purchasing power is falling.
    • Essentially, inflation erodes purchasing power over long periods of time.
    • Inflation is influenced by the Federal Reserve’s monetary policy, and the Federal Funds Rate which impacts short-term interest rates. Increased rates dampen inflation, improves the strength of the dollar, and removes frothy lending practices which helps moderate growth.
  2. What is the reported inflation rate, and why is it misleading?
    • The US Bureau of Labor Statistics releases inflation data.
    • The media typically reports on Core Consumer Price Index (CPI). However, Core CPI does not include price changes in food or energy.
    • Although food and energy are a core need for families, these prices can be very volatile, so they aren’t factored in to inflation data, thus eliminating two primary necessities in the data.
    • This is misleading because while reported targeted core inflation rate is 2% – 2.5%, food inflation has averaged 3.5% over the last 100 years. We’ve also seen gas prices increase from about 60 cents per gallon 40 years ago to today’s national average price of $2.41 according to AAA. One year ago, gas was $3.52 per gallon.
  3. Why inflation is a threat to retirees and those in retirement.
    • Most seniors live on a fixed income of about $25,000 per year, which includes social security, pension, and income from retirement savings.
    • Social Security and pensions can have cost of living adjustments, but they do not keep up with inflation, and seniors see their purchasing power diminished.
  4. What seniors and those nearing retirement can do about inflation
    • Don’t ignore inflation. Plan ahead with your financial advisor.
    • A lower risk strategy: Try to save more, spend less, and consider continuing to work.
    • Consider increasing risk tolerance in your retirement portfolio by investing in options that historically keep pace with inflation.
    • Keep withdrawal rates on retirement assets around 4% or lower.

http://www.investopedia.com/terms/i/inflation.asp
http://www.businessdictionary.com/definition/core-CPI.html
http://www.federalreserve.gov/faqs/money_12856.htm
http://www.wsj.com/articles/charles-r-schwab-raise-interest-rates-make-grandma-smile-1416441900
http://nypost.com/2014/05/25/how-inflation-could-destroy-your-retirement-nest-egg/
http://www.tradingeconomics.com/united-states/food-inflation
http://www.fuelgaugereport.com/
http://www.1970sflashback.com/1976/economy.asp