With the end of 2021 bringing one of the highest rates of inflation in decades, we have heard a lot of questions about inflation. The most important question however is what impact does inflation have on your wealth?
To answer that question, we have to look at exactly what inflation is, the factors forcing it to climb, and if it has any damaging impact on the Stock Market.
What Exactly Is inflation?
Inflation will likely impact many of your purchases at one point. So what exactly is Inflation? Inflation is the increase of a service or good’s price over time. To describe it better, inflation is what causes your current buying power to be less in the future than what it is today.
How Is Inflation Measured?
Inflation is measured and published every month by the US Bureau of Labor Statistics (BLS). You can view the inflation rate using the Consumer Price Index and view the most up to date Inflation data from their website.
To calculate inflation, a simple overview starts with goods and services packaged in a “market basket”. The month-to-month changes in price levels of this “market basket” is what gives us our basis for this measurement.
Inflation is then calculated from the comparison in the price level from the base period “market basket” to the “market basket” of goods in the most recent period.
The Current Inflation Rate
According to the Bureau of Labor Statistics (BLS), the annual rate of inflation from December 2020 to December 2021 was 7.1%. At the time we posted this article, this marks the highest increase in inflation since 1983. This also makes the steepest 12-month increase in inflation since 1991.
We have gathered some interesting figures of the current inflation surge. Gasoline, on average, costs 496.% more than last year. Energy prices have also risen dramatically to 29.3% higher than the year before.
Food prices have also risen, up 6.3% higher than in 2020. Lastly, used automotive prices have climbed as well, up 37.3% from the year before.
Your money buys you less today than it did a year ago. But this ratio generally holds true even at 30 years of average inflation. The real question then is whether the Stock Market is impacted – and how.
Inflation And It’s Impact
There is a lot of news circulating about inflation right now. You’ve probably heard that investors are worried about the impact inflation will have on the stock market, but are the concerns justified?
Dimensional funds created an interesting chart comparing periods of inflation to the performance of the S&P 500 over the last 30 years. It shows that there is little correlation between market performance and times of inflation.
Annual inflation-adjusted returns of S&P 500 Index vs. inflation, 1991–2021
During the period in the chart above, the S&P 500 had an average annualized return of 8.5% after adjusting for inflation. If you look back to 1926, the annualized inflation-adjusted return on stocks was 7.3%.
What do you do with this knowledge? As we have discussed many times before, long-term investing wins out over short-term concerns whether those fears are about inflation, politics, the economy, fed tapering, or rising interest rates.
It never hurts to remember a quote from Warren Buffet that said “The stock market is a device to transfer money from the impatient to the patient”.
Are we concerned about inflation? Absolutely. Will it change our investing fundamentals? Probably not.
We are always available to answer any questions or concerns you have about your investments or financial plan. Let us know how we can help.