No doubt about it, a dollar just isn’t what it used to be.
By any measure, the value of the greenback in 2008 is in retreat.
History, recent and otherwise, tells just how much in retreat. Take the average duration of a baby boomer’s lifetime.
- In 1958, $1.00 had about the same buying power as $7.38 in 2008.
- In 1968, $1.00 had about the same buying power as $6.19 in 2008.
- In 1978, $1.00 had about the same buying power as $3.38 in 2008.
- In 1988, $1.00 had about the same buying power as $1.82 in 2008.
- In 1998, $1.00 had about the same buying power as $1.31 in 2008.
The average annual inflation rate over the entire period between 1958 and 2008 was about 4%—fairly consistent with inflation’s historical growth. But over the past year, consumer inflation is up by 5%—the biggest inflation jump since May 1991, right at the heart of a recession.
Consequently, it’s the skyrocketing rate of inflation in recent months that has economists anxiously chewing on their pencils. Only a year ago, a gallon of gas cost about $2.50, meaning the price of gas has risen at a rate of well-over 50%. And it’s not just the price of gas which seems to grab all the headlines. Since March 2007, according to the Bureau of Labor Statistics, the price of eggs has jumped 35%; a gallon of milk is up 23%. If there’s any good news, core inflation, which excludes energy and food prices, is growing at a much slower clip – at 0.3% in May 2008.
No matter where you live, the real impact of inflation on consumers has become a burden. Now, thanks to rising inflation, millions of Americans are paying more for goods in an economic climate where their homes are worth less and their debt levels are climbing.
Call it the reverse “perfect storm” – one where your financial umbrella needs to be bigger and sturdier than ever.
Impact on your investments
This begs the question I have gotten a lot lately: how does inflation impact my investments, and what can I do about it?
The good news is that high inflation, as long as it’s not prolonged or higher than 5%, doesn’t impact your portfolio as much as you might think.
Historically, stocks perform well when inflation is truly in check, especially at 3% and under. Stock prices slow, but they still grow, when inflation averages between 3-5%. It’s when the inflation rate jumps higher than 5% that things really get ugly. When inflation rose past 12% back in the 1970’s, the stock market experienced its most prolonged slump since the Great Depression.
Yet, even at 5% inflation, individuals and businesses feel the pain. For example, people living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. While your income is etched in stone, the price you pay for goods and services rises, meaning more money goes out the door. Fixed-income investors fare no better. Take a bond investor who pays $10,000 for a treasury bill with a 5% yield. You may earn $500 from your investment, but higher inflation eats into that value as well.
Action Steps
So what can you do to help protect your investments?
At WrapManager, we believe in the power of diversity. To fight inflation, you need to be well diversified with investments that may help insulate you from the effects of inflation. As with any financial plan, of course, some investments are better than others.
One strategy is to hedge against inflation by hiring money managers that hold inflation-resistant securities in gold, silver or energy. Oil may be trending downward this week, but certain money managers believe the long-term prospects for oil are too good to pass up.
Ultimately, stocks have historically been one of the best inflation-fighting investments an investor can have. They may provide good protection against inflation, and continue to grow in value over time – faster than the rate of inflation.
Troubling times these are, but inflation needn’t get you into a financial stranglehold. When you apply the leverage instead of the other way around, inflation isn’t as sinister as it seems.
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