Fed Focus On Inflation
There’s been a lot of talk about inflation in Europe and Japan in recent years. In fact, Japan has been desperate to keep up with their inflation targets. Likewise, the Federal Reserve (led by Janet Yellen) here in the U.S. aims to have 2% inflation. The reason why there is so much focus on inflation is because it signals a healthy economy.
What Is Inflation?
We’ve all heard about inflation, but what makes it so special and what does it really mean? Inflation basically means that goods/services that we use every day become more and more expensive over time.
I’m going to use one example that strikes at my heart:
In 2002, California gasoline cost $1.56/gallon. My mother used to tell me about the “good old days” of $0.90 gas! Well, in 2015, gas now costs $3.22 a gallon, more than twice as much! $1.50 gas doesn’t sound so bad now, does it!
The reason why central banks (particularly in the U.S.) have stressed inflation targets is because it signals a healthy economy. One thing everyone fears is deflation–when prices decline over time. If that happens, consumer purchases slow! Why would you buy a big purchase now if it will only become cheaper the longer you wait?
Conversely, a high inflation rate (hyper inflation) can be just as bad. Venezuela’s inflation rate is set to be ~1,500% in 2017! That is ridiculous! By the time you stand in line with a loaf of bread, the price at the register would have already changed! High inflation rates are typically associated with economies on the brink of collapse.
In essence, we want a perfect goldilocks inflation scenario (not too high and not too low). This is why the fed stresses its 2% inflation target, the level which it believes signals a strong economy.
You Won’t Believe How “Cheap” Stuff Used To Be!
I was a bit about curious about how much everyday items used to cost 10 or 15 years ago so I pulled the data from the Bureau of Labor Statistics. Let’s take a look at some of them:
- Ground beef used to cost $1.80/lb in 1996…now it costs $4.25 or 2.4x as much!—that’s an annual growth rate of 4.6%!
- Eggs used to cost $1.11-per-dozen 19 years ago…now it costs $2.47/dozen or 123% higher!—that’s an annual growth rate of 4.3%!
- Bread used to cost $0.88/lb in 1996, how it’s $1.44 a pound! That’s a 2.7% annual increase!
While the price of common food items have increased over the past two decades, that pales in comparison to other purchases such as healthcare, education, childcare, and textbooks!
Take a look at this chart from Financial Samurai:
Over the past 20 years the price of:
- Textbooks increased 207%
- College tuition increased 197%
- Childcare increased 122%
- Medical care 105%.
Those are some pretty ridiculous price movements! I doubt the median household income in the U.S. increased by 150% over the past two decades!
And don’t even get started on drug costs! It seems every day another company is getting grilled over the ridiculous increase in prices. The latest is Mylan Pharmaceutical’s EpiPen, which increased more than 550% since 2007.
Inflation Can Be Deadly If Not Properly Managed
Inflation can be the greatest source of wealth destruction for many if not properly managed. This is because of the magic of compound interest—or in this case, compound inflation.
Compound interest is the eighth wonder of the world. He who understands it earns it…he who doesn’t pays it.–Einstein
Let’s see why inflation can put a serious dent in your nest egg:
Say you’re 35 and have $500,000 of cold hard cash saved in the bank. Assuming generously low inflation of 2.5% per year, your $500,000 would actually be only “worth” $238,371 in purchasing power 30 years from now. In other words, 30 years from now, your $500,000 will only be able to purchase half the goods it can now!
The only exception to the inflation rule might be consumer electronics, which have generally declined in price. However, if you need everyday items like food or gas or toothpaste then inflation is working long-term against you.
Now, I have been speaking ill of inflation for pretty much this entire article. However, don’t get me wrong. A moderate amount of inflation signals a healthy economy.
There Is Only One Way To Benefit From Inflation
If you’re not benefiting from inflation, you are going to lose out big time! Let’s talk about how we can all benefit from it!
The only way to protect or benefit from inflation is to invest. It doesn’t matter if it is in stocks or real estate or bonds or even commodities.
If you own the S&P 500, you own a piece of some of the largest companies in the US—these include companies in technology, consumer goods, energy, healthcare, and so many more.
When these companies raise prices, their earnings increase and they pay more dividends so the value of your holdings increase over time at a rate that even outpaces inflation.
Investing will protect you from inflation over the long run. In other words, you want to be the price giver, not the price taker:
- Tired of seeing the cost of toothpaste, deodorant, or razors go up? Why not just invest in the largest manufacturers of everyday consumer products: Colgate (CL) or Procter & Gamble (PG)?
- Tired of chicken, beef, pork and other meat prices increasing? Invest in Tyson Foods (TSN)!
- Tired of seeing your rent go up year in and year out? Invest in real estate and become a landlord. Now your income rises with the market! If you can’t afford to buy physical real estate, you can still simulate it by purchasing a public real estate investment trust (REIT)
Investment Strategies
If you’re new and getting started on investing, I would highly suggest rolling with Motif Investing. With Motif, you can buy a basket of 30 securities for one low commission of $9.95. Most other online brokerages (Scottrade, Fidelity, E-Trade, Schwab, etc) all charge $7+ for commissions to trade one stock! That means it would cost you $210+ to buy a portfolio of 30 stocks like what Motif offers.
Not only does Motif help you save costs, its interface also helps with risk management. You can create your own Motif portfolio or use thousands of professional designed portfolios.
So readers, what do you think about inflation? Why does it some people today don’t understand or care about it?