Inflation: An Old Frenemy Returns

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Even a casual glance at the financial news today confirms that inflation is “trending.” In fact, inflation has been dominating the headlines—and dictating much of the daily movement in stock and bond prices since before the end of 2021, having only recently yielded some influence to the ongoing war in Ukraine. While we hit a recent peak in March at 8.5% annually, the highest figure we’ve seen in 40 years, the 8.3% reported in April, while headed in the right direction, doesn’t suggest we are totally out of the woods just yet either.

Inflation measures the rate of increase in the dollar cost of goods and services and is typically expressed in terms of a rise or fall in the Consumer Price Index (CPI), the principal gauge of changes in the cost of living for consumers. At its most simplistic, inflation simply means that the purchasing power of a dollar is decreasing: in essence, too many dollars are chasing too few goods and services. Deflation, on the other hand, indicates that goods and services are becoming less expensive in dollars. Thus, since inflation drives up the price of basic goods and services, it makes living more expensive. The conventional view is that inflation is mostly a problem for the lower and middle classes. And especially for hourly workers, whose wages often do not increase to keep pace with inflation, the net impact is greatly reduced purchasing power and a resulting lower standard of living.

While this analysis is certainly accurate, it is inaccurate to assume that some families are therefore not affected by inflation, particularly those who do not rely on living paycheck to paycheck. Inflation certainly poses a significant number of daily problems for lower-income families, including even being able to provide the same meals and necessary items, and drive the same distances as just a few months ago. While these daily problems tend to subside in higher income households, inflation’s potential to reduce overall wealth—both now and in the future—is quite significant.

One reason is somewhat obvious: one of the first ways central banks, including the US Federal Reserve, tap the brakes on inflation is raising interest rates. Fed Chair Jerome Powell indicated recently that the Fed was considering one or more fifty-basis-point (0.5%) hikes in order to control inflation. But higher interest rates increase the cost of borrowing. This, in turn, is generally seen as making it more expensive for businesses to operate, which partly explains why Powell’s comments coincided with a dramatic fall in stock prices (the S&P 500 lost over 4.5% in value from April 21, when Powell made his comments, to April 22). Higher interest rates also directly increase the expense of the type of financing often used to operate businesses and acquire new assets.

But inflation, seen in its broadest sense, affects assets in other ways than reducing the value of stocks and costing more in interest payments. Viewed in the context of history, inflation also makes it more expensive for individuals to acquire the very assets on which their lifestyles depend.


When you consider that high stock prices reduce the value of dividends proportionately, and that low bond rates (still at historically low levels) make interest income more expensive to obtain, the cost to “buy” $1,000 a year of income in the investment markets has risen considerably. In 1990, if you invested $25,000 in a portfolio evenly divided between stocks and bonds, that portfolio would generate around $1,000 a year of income. Today, to achieve that same amount of income from a 50/50 portfolio, you would need to invest roughly $80,000. So, while stock and bond prices are not included in the calculations for inflation as measured by the CPI, this type of “investment income inflation” clearly presents problems for investors looking to secure a stable income stream for the future. Historically, it has also been true that certain asset classes perform better during inflationary environments and can act as an effective hedge, particularly real asset categories such as real estate, REITs, and commodities.

At Treehouse Wealth Advisors, we understand that the effects of inflation can be felt in a variety of different ways. We provide a range of financial services to help clients feel more confident in their financial decisions. When you work with Treehouse Wealth Advisors, you can have peace of mind knowing your financial picture is being taken care of behind the scenes while you balance a busy career, family, and community. If you are looking for more information on our wealth management solutions, we would love to meet you!
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