Inflation has been one of the buzzwords in the news media for the past couple of years.
It was front and center in the contentious political campaigns in 2024, as well.
Good or Bad?
The basic reason that most people care about inflation is simple: Inflation measures an increase in prices, which you and I must then pay. The same amount of food that you bought last year might cost 10% more than it did one or two years ago. Rent and insurance may have gone up 15% or more in that same period. Everything from doctor visits to meals at restaurants, plane flights, and clothing just costs more than it did 12-24 months ago.
On the other hand, some inflation is the sign of a healthy, growing economy. The Federal Reserve believes that a healthy inflation number is around 2%. When an economy is growing and seeing increased employment and productivity, wages usually rise. These are good things!
However, with more people working at higher wages, there is more money pursuing goods and services. This increase in demand generally causes prices to rise. When this cycle gets out of hand, in what sometimes is called a wage-price spiral, wages and consumption feed additional price increases, which feed more wage increases, and the spiral keeps on going. It can be hard to slow down, so the Fed would rather slow the whole economy and, possibly, increase unemployment to stop it.
Another pro-growth positive of moderate inflation is that it encourages spending today because people assume the same thing will cost more tomorrow. In the US, consumer spending is a major component of economic growth, so encouraging it is usually seen as a good thing until that consumption causes too much borrowing and puts households at risk.
One last negative: When inflation gets too high, let’s say 5%, which is twice the Federal Reserve’s target, consumers often suffer, because their incomes are not growing in real terms. You might get a 4% raise but when inflation is 5%, your purchasing power declines by 1%. In 2022, when inflation averaged 6.5%, real incomes had a hard time keeping up.
By now, I’m sure that you get the picture. A little inflation that remains under control, think a campfire rather than a wildfire, is a good thing. However, too much of a good thing can lead to problems. The Fed has spent the last two years trying to reduce problematic inflation and get it under control. While there may be a little way to go, with CPI now at 2.9%, the goal is in sight. Now that the Trump Administration is in office, the question is whether new policies will help keep inflation under control or contribute to another round of unwelcome price increases.
What Can I Do About It?
Like the stock market, there’s not much an individual can do to control or change price inflation. Here are four things you should consider doing to help manage inflation’s impact on you.
1. “Anchoring to past prices” isn’t helpful. In economics, anchoring means that, in your mind, you’ve locked onto a past price as the right and unchangeable price. Anchoring can make us feel that things are worse than they really are.
In 2010 for example, a Big Mac cost $3.58. Today, the same sandwich costs $5.29, an increase of $1.71. That may seem like a big increase if you are anchored to the $3.58 price. But the rate of increase for that price change is only 2.5% per year, pretty close to what the Fed says is “healthy”. When you stop and do the math, you’ll realize that the new price makes sense even if you don’t like it and is not a sign of runaway inflation.
By the way, the older you get, the more susceptible you are to irrational anchoring. In 1979, when I had a Big Mac after every high school basketball game, it cost 99 cents! To me, at first blink, that $5.29 seems outrageous! However, a little math confirms that my Big Mac has increased at an average rate of 3.75% per year since 1979, hardly an economic signal of catastrophe.
2. Make sure your cash accounts (savings accounts, CDs, money markets) are yielding today’s higher rates. In 2021 through 2023, as inflation rates climbed as high as 9%, the Federal Reserve raised their interest rate from zero to 5.33%. They did this because economic theory and history show a link between rising interest rates and lowering rates of inflation. At higher rates, it becomes more expensive to borrow money, but it also becomes more attractive to save. Treasury Bills, CDs and money markets in 2023 began to pay more interest to savers than in the previous 10 years. Even today, a year after very favorable rates, many depositors have not checked bank accounts, which still may be paying below market rates of interest. CDs and US Government backed money market funds are yielding over 4% in early 2025.
3. Position your long-term investments to outpace inflation. Historically, a diversified stock portfolio is one of the very few investments that have regularly outpaced the rate of inflation. For those investors building retirement accounts, long-term real growth (growth exceeding the rate of inflation) is important as a part of the overall retirement portfolio. Stocks can be risky in the sense that their prices can go way up and way down without a moment’s notice. But the track record for stocks since 1950 reflects a real return of 8.09%1. $1,000 dollars invested for 20 years at this real rate of return would increase purchasing power available to the investor by close to $3,800!
4. Finally, you can consume less or substitute something whose price is not rising as fast. For example, if oranges are increasing in price at 10% and apples at 5%, you could forgo oranges in favor of apples. This is how comparing apples and oranges really works! You’re still eating healthy fruit, just a different variety.
Inflation at moderate levels can be a sign of a healthy economy. But when it gets out of control, approaching double digits, usually the economy is headed for a slowdown or recession. Like many economic indicators or market measures, what inflation will do in the future is very unpredictable, just ask the Federal Reserve!
However, inflation does not have to derail our financial plans. As always, it’s crucial to plan and invest assuming uncertainty, to prepare your plan and portfolio for a wide range of future possibilities. With the right preparation, there are very few financial storms you won’t be able to navigate. If you’d like to check your levels of preparation with a financial advisor who genuinely cares about you and your unique situation, please contact us at Foster Group—we are committed to helping our clients achieve their goals, whether they’re planning for their families’ futures or striving to make a difference across the world.
1 Using average annualized returns from January 1, 1950 through December 31, 2024 for the S&P 500 (11.61%) minus the US CPI (3.52%). Data provided by Dimensional Fund Advisors.
