The stock market has been performing at historical highs and the Feds are starting to raise interest rates. For the first time this year, the Fed raised its key short-term interest rate to a range of 0.75% to 1%. That’s the highest the rate would be since 2008. Generally speaking, the Fed feels confident in the growth of the economy and it is likely to continue raising interest rates slowly. But how exactly will this affect your wallet? What does this all mean for your everyday purchasing power?
Inflation, by definition, is the general increase in prices and the fall in the purchasing value of money. In other words, the costs of goods and services rises faster than the value of your dollar. When your salary stays the same or increases less than inflation, it makes everyday purchases more expensive and restricts your income from going as far as it used to.
As a consumer and investor, here is what you need to know about inflation in 2017 and how you can protect the value of your money.
Mind Your Spending
Yes, the economy is rallying, but your ability to purchase more is diminishing. Therefore, it’s especially important to be mindful of your consumption these days. Everything from the cost of milk at the grocery store to movie tickets, theme park tickets, and retail clothing is on the rise.
If you have any revolving credit, such as a Home Equity Line of Credit (HELOC), expect the rate you are charged on that to rise as well.
According to Trading Economics, consumer prices in the United States increased 2.7% in one year as of February 2017. They report this as the highest inflation bump since March of 2012.
Don’t Sit on Too Much Cash
I have talked before about the importance of an emergency fund holding roughly three to six months of your expenses. But don’t sit on more cash than what is absolutely necessary to protect you and your family in the event you were to lose your job. Depending on your age and how long you think it would take to secure another job in the event you lost your income, will help you determine just how much you should have saved up for a rainy day.
One of the main reasons for not sitting on too much cash is that despite your borrowing costs rising, the rates you are earning in your savings account often don’t move as fast, and if and when they do it won’t be equal to the rise of your borrowing costs.
Investing in Stocks Makes Sense Right Now
Stocks have historically continued to perform well, even after inflation (Jeremy Siegel Kiplinger, 2011). Despite the current markets continued rise, now is still a good time to invest while the inflation rate is at about 2.7%. The reason for this can be attributed to the fact that unlike bonds or other types of investments, stocks are claims on actual assets. So when the value of a stock (i.e. value of a company or product) increases, so too does your position in that stock.
However, once the inflation rate rises higher than 5%, stock prices typically start to fall or stagnate, because investors fear increasing interest rates will slow future growth. Optimistically, the returns that you have already gained in the stock market can help offset future losses for a net gain that has historically more potential than the return on bonds in this same environment. It is for this reason that stocks are a good long-term investment strategy for most investors right now.
Inflation can be a hindrance on the economy because it makes saving money more challenging due to the rising costs of goods and services. That being said, while rising inflation and interest rates that make it more expensive to spend and borrow money, if you are able to continue investing your money into your retirement account, as Siegel says “for long-term investors, stocks will be an excellent hedge against rising prices”.
