Inflation 101: It's Called Supply and Demand

The Importance of Investing in Assets

This image makes me think of cash just sitting when inflation soars. It is hard to not hear about, see, or feel the affects of inflation and its ability to impact our lives. News talks about it, your neighbors (we all still talk to them, right?), your coworkers, social media, it is everywhere. It is important to understand some of the factors that cause inflation, in addition to some of the tools and resources that can be utilized to help combat it to sustain your purchasing power and future living standards. The cost of living has increased significantly in the United States, really the entire world, over the past few decades. From 1960 to 2021, the average inflation rate was 3.8% per year. This means that an item that cost $100 in 1960 would cost $929.57 today. For September 2022, the year-over-year inflation rate was 8.2%. There have been years in the past with higher inflation rates, but this exceeds the desired rate of 2–3%. This number represents the importance of having money invested in assets like stocks, real estate, and precious metals.

For families across America, the cost of living seems to increase every year, while wages seem to remain stagnant. This is because the cost of goods and services goes up with inflation, but salaries typically don’t keep pace or are in line with inflation rates. This is why it is important to invest in assets, to ensure that your standard of living can keep up with the rising costs. Over time, these assets will increase in value at a rate that exceeds inflation, giving you more purchasing power and protecting your standard of living. No one wants to work for the better portion of their life just to get to “retirement” to find out that their living standard is less than when they were working full time. I put quotations around the word ‘retirement’ simply because retirement may look different from person to person.

What Causes Inflation?

In order to understand how investing in assets can help you keep up with inflation, it is important to first understand what causes inflation. To simplify the numerous factors that influence the volatility of inflation, inflation is caused by an increase in the money supply, which can lead to increased demand. When there is more money chasing fewer goods and services, prices go up. This is why you often hear about inflation being caused by “too much money chasing too few goods.” Between the flow of money increasing and the amount of people to move goods and provide services decreasing during the height of Covid-19, it was a big reason why we are still dealing with these elevated inflationary pressures today.

There are a number of factors that can cause an increase in the money supply and inflation, besides the one mentioned above, such as:

  1. The Federal Reserve printing more money
  2. Borrowing by the government
  3. Deficit spending by the government
  4. Trade deficits
  5. Supply Chain Bottlenecks

All of these factors can lead to inflation, and they often do. For example, the Federal Reserve has been printing a lot of money for, well, a long time (especially during Covid-19), and this has caused inflation to gain immense speed. The government has also been borrowing and spending more than it ever has before. These factors, along with many others, have contributed to the high inflation rates we’ve seen in recent years. The supply chain bottleneck factor mentioned above has been a huge issue ever since governments across the world threw a wrench in the global supply chain in an attempt to combat Covid-19. It had been very difficult for companies across the world to adapt to the strict guidelines that were enforced during Covid-19, which ultimately decreased the supply of goods while the demand remained hot. Increased demand with a decrease of supply is the main factor that contributes to price increases.

Side note, see how often it is the government that is causing inflation? I digress.

What Assets Should You Invest In?

Now that you know what causes inflation, you may be wondering what assets you should invest in. While there are a number of different assets you could invest in, some of the best include:

  • Stocks: Over the long run, stocks have outperformed most other asset classes. They offer the potential for high returns, and they’re relatively easy to buy and sell. They are also more volatile than many other assets, so plan to have a long-term horizon for all forms of investments to ensure you are not making poor short-term decisions.
  • Real estate: Real estate has also been a solid investment for long-term investors. It’s a tangible asset that can be used for housing or rental income, and it tends to appreciate in value over time. Contrary to the value of the dollar, housing has increased tremendously over the course of history.
  • Precious metals: Gold, silver, and other precious metals are often seen as a safe haven during times of economic uncertainty. They offer the potential for high returns, and they can be used as a store of value.

These are just a few of the broad assets you could invest in. There are many others, such as bonds, commodities, and collectibles. The key is to diversify your portfolio so that you’re invested in a variety of different assets. This will help to protect you from inflation and give you the potential for high returns. There are numerous other articles on this site that provide specific funds and REIT’s that you can invest in if you wanted more specific examples compared to the broad categories of investment tools. Check out this article for some ETF’s to invest in and this article for one of my favorite Real Estate Investment Trusts.

This is what your portfolio can look like being diversified across numerous asset classes. Much better than the first image, isn’t it?

Investing in appreciating assets is one of the best ways to protect your purchasing power from inflation. Many employees have been given higher than average wage increases over the past year, but are still losing purchasing power due to the increased level of inflation (hopefully that will continue to subside as the CPI report in November showed a decrease in inflationary pressures). As was mentioned above, assets tend to increase in value at a rate that outpaces inflation, which means that your investment will be worth more in the future. So, whether you decide to continue to hold onto those investments to collect dividends or use them for future purposes, you will have an increased ability of sustaining a larger purchasing power due to the investment decisions you get to make today. There are a number of different assets that you can invest in, so it’s important to do your research before deciding which option is best for you. However, as long as you choose an asset that is expected to appreciate over time, you should be able to beat inflation and protect your standard of living for years to come.

 

*This is not financial advice. For educational purposes only.

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