Inflation is an important indicator of an economy’s health, as it indicates how the costs of goods and services are rising. While consumers often look at the prices of individual products as a gauge of their affordability, they have a broader need for a wide range of commodities. These include food grains, metal, fuel, utilities, transportation, entertainment, and labor. Rising prices of commodities are often the main cause of inflation, and they must continue to rise in order to maintain economic growth. While inflation may be good for the economy, it can pose a threat to investors. Inflation can impact not only your spending but also your savings and investments. Rising inflation can hurt your savings and investments in many different ways:
- Forcing tough choices: … People cutting back spending in one area of their life due to unavoidable inflation elsewhere reduces revenue for those companies associated with those less-immediately essential products. That can hurt the stocks associated with those types of companies.
- More aggressive cost-cutting actions: When companies are faced with higher costs, they start getting aggressive with their cost-cutting actions. That could include things like changing formulas to reduce input and processing costs, reducing staff to cut salary and benefit costs, or stretching out maintenance cycles to reduce downtimes.
- Higher borrowing costs: If you’re in the market for something that you can’t pay cash for (such as a house or potentially a car), you will borrow money to complete the transaction. If inflation means the price of that item is higher today than it was in the past, you will likely both pay more and borrow more for that item.
- A greater need to hold assets in other forms: As a general rule, money you expect to spend from your portfolio within in the next five years does not belong in stocks. If you’re a retiree who expects to spend $40,000 per year from your portfolio, that means you’ll need $200,000 in lower-risk investments, assuming no inflation.
- Better risk-adjusted returns elsewhere: Low interest rates have helped bolster the stock market. It stands to reason that if rates rise in response to inflation, the stock market can get hurt as the money forced into stocks by lower rates can find better risk-adjusted returns elsewhere. Read more
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