Why Inflation Matters So Much in 2022

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Friday, January 28, 2022

Now More Than Ever: Why Inflation Matters So Much in 2022 and What You Can Do To Beat It

Investors in the United States had for some time been anxiously looking forward to the January Federal Reserve’s meetings which took place earlier this week. Recent concerns over rising inflation, which was a 40-year high of 7% in the U.S. last year, coupled with how the Fed might combat inflation have contributed to the rocky start that many stocks and cryptocurrencies have had so far in 2022.

After those meetings on Wednesday, the Fed released a statement that seemed to provide some clues regarding how they would use interest rate hikes, possibly beginning in March, to reduce inflation. However, what might be lost for you in the subsequent chatter regarding how many times the Fed will raise rates in 2022 and 2023 to address inflation is what the long term effects of even modest inflation have on our lives.

While inflation is not inherently bad, there are three key things that you should understand about inflation:

1. what inflation is,

2. why inflation matters, and

3. what each of you can do to beat inflation.

Inflation simply refers to the rate of decrease in the purchasing power of a given currency over time. Each pound, euro, dollar, etc. will be able to purchase less goods and services as time goes on. This diminished purchasing power is typically represented via the consumer price index (CPI).

The CPI is a measure of the price of a basket of goods and services purchased for consumption that changes over time. In the United States, the Bureau of Labor allows you to calculate exactly this change over time. For the period ending last month, costs have risen nearly 25% since January 2012, and 65% since January 2000. Essentially, the power of the dollar has shrunk by 23% and 65% respectively over these periods. Not coincidentally, Dollar Tree recently raised their prices to 1.25 USD, which leads us to why inflation matters.

Inflation matters first because this tool can be used to help determine the state of a given economy. Secondly, the specific rate of inflation will also help inform what next steps should and will be taken to address it. In fact, governments and businesses routinely make important decisions based on this information.

Governments will typically utilize interest rates as a tool, lowering or raising them, in order to maintain a desired level of inflation. Businesses will typically balance price and wage increases in order to reduce their costs while maintaining their ability to continue to attract talent. These measures allow them to more effectively navigate these inflationary waters.

However, when wage growth does not match inflation growth, workers still end up effectively making less money. This was the case in the United States in 2021. The average American worker saw his/her pay increase by 4.7%, but the 7% overall inflation rate resulted in workers effectively taking a 2.3% pay cut.

Superficially, losing 2.3% may not seem like a big deal, but unchecked, this loss rate will mean a 10.98% pay cut / loss of purchasing power for you in the next five years. Thankfully, you, just like governments and businesses, have tools at your disposal to combat inflation. Therefore, you do not simply have to be at the mercy of employers who won’t at the least match wage increases with inflation increases.

Since wages don’t typically rise at the same rate or higher as inflation, this further highlights the need for, and the power of, investing. Investing has long been viewed as incredible protection against inflation, since their returns can outpace even the highest inflation rates. (Investopedia lists the average annual returns of the S&P 500 as slightly under 11%.)

Including the rough start that equities are off to in 2022, investing in an S&P 500 index fund in 2012, such as the SPDR S&P 500 ETF Trust (SPY: NYSEArca) would have yielded you a 267% inflation adjusted return now. A Bitcoin investment 10 years ago would have yielded an even more eye-popping 602,198% inflation adjusted return. Each of these returns substantially outpaces the 23% rise in costs over that same period.

However, the key to achieving these numbers is for you to think the opposite of the way that most people think and behave differently than the way that most governments and companies behave. Your having a longer investment time horizon and subsequently asking a different question when it comes to your investments should prove extremely beneficial for you.

For example, instead of only asking yourself, or your financial advisor, “What stocks are poised to have a huge 2022?”, also ask “What stocks are poised to have a huge 2032?” Everyone is necessarily asking the former question, yet few are asking the latter. Your selecting the right investments now for 2022 will yield good results, but doing this now for 2032 will yield you stratospheric returns as we highlighted above.

No matter your timeline, we’re here to help you get the best investment results. To partner with us, or to reach out with comments, questions, or concerns, please email us at info@taryagfinancial.com. (Image above courtesy of Getty Images)