Here's Everything Investors Need to Know About Inflation in 2021

Inflation has been around for decades, and following a year of economic instability and uncertainty, it seems as though many of us are turning our attention to inflation which has recently piqued national interest. In fact, a recent study found that people are Googling the word “inflation” at a rapid rate, with a peak not seen since 2008.¹   

Since the beginning of the COVID-19 pandemic, there have been six major stimulus bills passed by congress and has totaled around $5.3 trillion. With these efforts to alleviate pandemic-fueled financial strife, the question arises, are inflation levels being impacted?

Fed Chair Jerome Powell has said that as the economy begins to recover from the Covid-19 pandemic, inflation will likely pick up as well however, he believes it will only be temporary. Powell has also stated that the central bank plans to keep short-term rates anchored near zero through 2023.²  

As you consider any potential changes to inflation we may be seeing this year, here’s an overview of inflation and the impact it may have on investors this year.

What Is Inflation?

Inflation is defined as an upward movement in the average level of prices. In simpler terms, inflation is the decline in your money's purchasing power over time. Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) to track these fluctuations.

Understanding the Consumer Price Index

The CPI was developed based on information provided by families and individuals on purchases made in the following categories:³  

• Food and beverages
• Housing
• Apparel
• Transportation
• Medical care
• Recreation
• Education and communication
• Other groups and services

Although the Consumer Price Index is the commonly used indicator of inflation, it has come under scrutiny. For example, the CPI rose 1.4 percent between January 2020 and January 2021 – a relatively small increase. However, taking a closer look at the report, it shows the movement in prices on various goods tells a different story. Used car and truck prices, for example, rose 10 percent during those 12 months.⁴ 

Investments & Inflation

Inflation can affect investors and their investments in a variety of ways. Most notably, inflation can reduce the rate of return, risk purchasing power and influence the Federal Reserve.

Rate of Return

One of the most significant ways that inflation affects your investments is by reducing the real rate of return on investments. Say an investment earned six percent over a 12-month period. During that time, let us say inflation averaged about 1.5 percent. That would mean that your investment’s real rate of return would have been 4.5 percent - not six percent.

Purchasing Power

Inflation puts your purchasing power at risk. Like mentioned above, inflation can be defined as the decline of your money's purchasing power over time. So, when prices rise, a fixed amount of money has the power to purchase fewer goods and services.

The Federal Reserve

Inflation can also influence the actions of the Federal Reserve. If they want to control inflation, the Federal Reserve has several ways in which it can reduce the amount of money in circulation. Typically, when the Federal Reserve wants to slow the economy it raises interest rates which then generally lowers inflation. Hypothetically speaking, a smaller supply of money means less spending - which could equal lower prices and lower inflation.

With a lot of changes over the past year or so, it is no surprise investors and consumers are concerned about the rate of inflation today. When inflation is low, it’s easy to overlook how rising prices are affecting a household budget. Alternatively when inflation is high, it may be tempting to make changes to your financial standings and portfolio. If you’re concerned or have any questions about the inflation rates we’re seeing in 2021, reach out to your trusted financial professional as they can help determine if changes need to be made to your portfolio or if you and your portfolio are already well-prepared.