when inflation persists | Benzinga
Inflation is rising rapidly. And he may be here to stay.
The Fed said so on Wednesday, saying it was less confident that this rise in inflation might be only temporary. Fed Governor Jim Bullard surprised investors on Friday by suggesting that inflation could persist next year and force the Fed to raise interest rates.
We have now seen two straight months of core consumer price index (CPI) year-over-year growth of 3% or more, the first time since the mid-90s. Sure. , there are base effects, and the drivers of recent inflation look like temporary vagaries of supply chain issues and post-COVID dynamic.
But maybe it’s time to start thinking about what a world characterized by consistently high inflation looks like.
Inflation can be a difficult trend to navigate. In the past, high inflation led to economic recessions and lower stock returns.
Don’t let inflation scare you off of the markets, however. In fact, it’s more important than ever to stay invested and engaged.
Why? We’ll tackle this with a bit of math.
The value of money
Take your calculators. Here’s a crash course in the time value of money.
Prices in the United States have steadily increased over the past decades. When prices are constantly rising, you may find that your paycheck does not extend as far as time goes by. This is because inflation erodes the value of money over time.
Think about the dollar. A dollar bill may be worth $ 1 now, but it is likely not to be worth a dollar in the future. Like any currency, it can lose value over time as inflation rises. If inflation increases 3%, $ 1 now would be worth 97 cents a year from now on. Three cents may not be that much, but the impact of inflation can snowball over time.
Let’s say you are sitting on $ 100,000 in cash and the inflation rate (discount) is 2%. In 10 years, that $ 100,000 today could be worth about $ 82,000. Raise that inflation rate to 3%, and that $ 100,000 might only be worth $ 74,000 in 10 years.
The power of the present
Your wallet can be one of your best tools in dealing with the burden of inflation on your finances.
The growth of the stock markets has historically exceeded inflation. In fact, the S&P 500 has grown an average of 8% per year since 1990. Compare that to the 2% average annual growth in the core CPI over the same period. This is one of the reasons why investing can help you build your wealth.
The trap ? You have to start early and stay invested. It’s always wise to start early, but it’s especially important when cash loses purchasing power in an environment of high inflation. Additionally, you need to give your portfolio as much time as possible to reap the benefits of compounding and counter the weight of inflation.
Easier said than done, however. Society and the markets are exceptionally focused on instant gratification. Your brain is also not wired to think far into the future. There’s even a cognitive bias called hyperbolic discounting, which occurs when you ignore larger long-term payoff for short-term rewards. The fight is real.
To be fair, it’s wise to keep cash on hand for emergency spending and investment opportunities. But remember: investing early can give your portfolio its best chance for success, even when inflation hits.
Short term vs long term
You have started to invest. Awesome. Now let’s go further.
There is many classic ways to hedge against rising prices, including cyclical stocks, gold, TIPS (Treasury Inflation Protected Securities) and non-traditional assets. Of course, you should also take your individual needs and considerations into account.
But no matter where you look, it’s important to prioritize cash flow over growth potential when inflation soars. Short-term payments can actually help you maximize long-term growth. It sounds counterintuitive, but listen to me.
Think back to our lesson on the time value of money. When rising inflation results in higher rates, the present value of future growth (and money) is lower. High-end stocks generally trade assuming growth potential over time, and higher inflation could reduce that potential. Growth has its place in the portfolio, but it may not shine as brightly now as in an environment of low inflation and low interest rates.
Instead of waiting for a growth-oriented stock to blossom, it may be worth checking out dividend stocks. While dividend payers aren’t usually the hottest companies – toilet paper makers, grocery distributors, and power companies – their payments could help you get money back faster (at current likely higher). And if you reinvest that dividend payment, you may be able to boost your portfolio growth over time.
You don’t have to look far to find dividends, either. About 76% of S&P 500 companies pay a regular dividend, and many of them pay one quarterly. Plus, stocks could give even more money back to shareholders after impressive earnings growth this year. In fact, S&P 500 companies increased their dividends by $ 20 billion in the last quarter, the biggest increase in nine years.
The bottom line
This surge in inflation may be temporary, and if it does, it might just be echoing on the radar for the economy and the market. However, inflation can be a self-fulfilling prophecy, and Wall Street comes to the idea that this inflation surge may persist.
But inflation doesn’t have to doom your wallet. It can even help you uncover important opportunities to put your money to work. Let the math work in your favor: Think about the impact of the time value of money on your investments, and be prepared to profit if the market slips on fear of inflation.
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