Inflation Rate: What You Need to Know About Rising Prices

Key Takeaways

• It is essentially the rate at which the price of goods and services rises.

• Inflation can ensue if the nation’s money supply grows at a faster clip than the economy’s ability to turn out goods and services.

• A frequently utilized metric for measuring inflation is the consumer price index (CPI), which is calculated by the U.S. Bureau of Labor Statistics.

The last year has seen record inflationary highs, forcing consumers to adjust to meet their obligations. Such economic conditions – the rate increased 3% in June, although outlooks are improving — also affect investors, in that inflation indicates how much of a return investments must make to maintain a certain standard. 

Still, many investors are unsure how to manage their portfolios during inflationary periods. So, here is, inflation rate: what investors need to know about rising prices.

What is “Inflation Rate?”

While the term has headlined many news stories, what exactly is “inflation rate”? It is essentially the rate at which the price of goods and services rises. When inflation occurs, the buying power of money – money’s value — drops over time.  

What is the Cause of Inflation?

While many people know first-hand that inflation causes prices to increase, they do not know what causes it. The most recent inflationary period was sparked, at least in part, by pent-up consumer demand, supply-chain problems, and stimulus from the COVID-19 pandemic.

Inflation can also be driven by heightened production costs. What is called cost-push inflation occurs when prices related to production processes such as wages or raw materials go up. 

Moreover, inflation can ensue if the nation’s money supply grows at a faster clip than the economy’s ability to turn out goods and services.

How Can We Measure Inflation?

There are metrics that help explain the inflation back story, including the personal consumption expenditures (PCE) price index. The U.S. Bureau of Economic Analysis calculates the PCE, which prices certain goods and services and compares them to previous periods.

Then there is the producer price index, which evaluates the average change over time in prices received by domestic producers for their output.

A frequently utilized metric for measuring inflation is the consumer price index (CPI), which is calculated by the U.S. Bureau of Labor Statistics. The CPI is measured by monitoring the average price change paid for disparate goods and services in these classifications: housing, food, clothing, recreation, medical care, transportation, communication, and education. 

Factors that Influence Inflation Rates

There are various factors that influence inflationary rates, including:

1. Monetary and fiscal policy. Because it also affects aggregate demand, fiscal policy can support monetary policy in handling inflation. To combat inflation, monetary policy can lessen demand and re-anchor future inflation expectations. While such effects can be undermined by expansionary fiscal policy, contractionary fiscal policy can undergird them.
2. Supply and demand dynamics. Drops in aggregate supply are commonly precipitated by production cost hikes. If aggregate supply decreases but aggregate demand stays the same, prices and inflation are subject to upward pressure. 
3. International trades. When a major portion of a nation’s trade is dominated in foreign  currencies, the inflation rate is more formidably affected by exchange-rate fluctuations.

The Impact of Inflation: Winners and Losers

Inflation’s effects are far reaching, both positively and negatively.

Consumers. In addition to higher prices that can overextend budgets, consumers also face other inflation fallout. During fast-rising inflation, for example, interest rates hardly ever keep pace, causing consumer savings to gradually lose purchasing power. Retirees with fixed incomes are also hurt by inflation, as are investors in longer-term bonds as well as homeowners with variable-rate mortgages.

Note, though, that borrowers do generally benefit from unexpected inflation since the     money they repay is worth less than the money borrowed. Fixed-rate mortgage holders also benefit in that mortgage interest rates are locked in for the loan’s life, meaning they will not fluctuate with inflation. Then there are property owners, who are not subject to increasing rental costs during inflationary periods.

Businesses. In addition to consumers, businesses during inflationary periods are also hit by loftier borrowing costs, as the Federal Reserve raises interest rates. Increased borrowing costs render it more expensive to finance new businesses (as well as homes), both of which are essential for a thriving economy. In general, when inflation rates rise, just about every aspect of business becomes more expensive, and businesses may be hesitant to expand.

Overall economy. Because investors and consumers are, to some degree, deleteriously affected by inflation, the economy can suffer dire consequences. Because the money that consumers have cannot purchase as much as it once did, individuals might curb their spending – particularly if they do not get a pay hike to offset higher prices. This could hurt demand, which consequently threatens business profitability and demand. 

Should You Invest During Times of Rising Inflation Rates?

As part of a diversified portfolio, it may be a smart move to keep a portion of capital in long-term investments during inflationary periods. This permits investors to grow their money gradually over time and keep pace with rates of inflation.

While no investment is risk-free, alternative assets – those not directly correlated with stocks and bonds – are generally less volatile, even in times of economic instability. Such asset classes, which include art and real estate, can help with diversification, the practice of spreading assets around to limit exposure to any single type of asset. Diversification is key to successful investing in general, and even more so during periods of inflation.

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

During periods of upward-trending prices, investors generally seek returns that are at least the same rate as inflation. To help safeguard portfolios, however, it is crucial that investors diversify their holdings. Adding alternatives could provide extra protection, since such asset classes generally, and inherently, guard against inflation.