9 things to remember about inflation
After years of only mild price increases, higher inflation is making an appearance. That's why now is a good time for this refresher on inflation and how investors can hedge against it.
1. It's been worse.
Inflation hit 7.5% in January 2022, the highest 12-month increase since 1982. Steep, yes, but singnificantly less so than during the 1970s and early 1980s when inflation by double-digit percentages.
Average annual inflation rates over the past 50 years
The 3 highest are 13.5% in 1980, 11.5% in 1979, and 11% in 1974.
The 3 lowest are -0.4% in 2009, 0.1% in 2015, and 1.2% in 2020.
Source: Federal Reserve, Bureau of Labor Statistics
2. There's more than one version of the Consumer Price Index (CPI).
The most widely used measure of inflation and broadest is the CPI for All Urban Consumers. The CPI-U represents 93% of the U.S. population.
3. The CPI is calculated by measuring price changes from month to month.
Bureau of Labor Statistics data collectors track the price of 80,000 goods and services each month. This basket of items is updated every two years to reflect changes in consumer buying habits.
Inflation by category
All Items is 7.5%, Food is 7%, Energy is 27%, and All Items Less Food + Energy is 6%.
Source: U.S. Bureau of Labor Statistics, 12-month percentage change, Consumer Price Index, January 2022.
4. The IRS regularly adjusts benefits, tax brackets and many tax breaks for inflation.
Case in point: In 2022, retirees are receiving a 5.9% raise in Social Security benefits, and you can contribute an extra $1,000 in your 401(k). But in prior years, when prices fell or remained mostly flat, there were no increases. For example, Social Security recipients saw no cost-of-living-adjustment in 2010, 2011 and 2016.
5. Strong demand and supply shortages are helping drive inflation today.
As the economy rebounds, so has consumers' demand for goods and services. But suppliers- faced with shipping disruptions, production declines and labor shortages - haven't kept up, pushing prices higher.
6. Some inflation is good.
If consumers expect prices to rise, they'll make purchases sooner rather than later - and that's good for economic gorwth. The Federal Reserve, with a mandate to promote maximum employment, stable prices and moderate long-term interest rates, has a target rate of 2% inflation.
7. Deflation - sustained falling prices - can be worse than inflation.
When consumers expect prices to drop in the future, they hold back on spending. Companies then cut production and profits fall, which can trigger wage cuts, layoffs and economic downturns.
8. The Federal Reserve tries to fight high inflation by raising interest rates.
Higher interest rates make it more expensive to borrow, so consumers spend less. That slows the economy and reins in inflation. Fed policymakers are widely expected to raise interest rates three or four times in 2022.
9. Inflation-resistant investments can provide a hedge against rising costs.
Traditional hedges include:
- Treasury Protected Inflation Securites (TIPS), which are government bonds whose principal rises with inflation. You can purchase them directly from the government or invest in an inflation-focused fund that buys TIPS.
- I-Bonds, which are U.S. Savings Bonds with an interst rate that's adjusted for inflation.
- Stocks, particularly in certain sectors such as energy, healthcare and consumer staples where customer demand remains steady even if prices go up.
- Real estate investment trusts (REITS), that own, and/or manage offices, shopping malls and other properties, and can raise rents during inflationary times.
- Commodities, whose prices tend to go up with inflation.
- Gold, another commodity that has traditionally been viewed as a hedge against inflation, although that record is mixed.
Learn more about what you can do to help protect your money from inflation with a Fidelity Viewpoints special report. Go to https://www.fidelity.com/learning-center/trading-investing/money-and-inflation
Copyright March 2022 The Kiplinger Washington Editors Inc.
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