By Associate Financial Adviser: Daniel Carnes
Everyone remembers how much a gallon of gasoline cost when they were growing up. For most Baby Boomers it was less than 50 cents a gallon. This phenomenon of prices of goods and services risings over the years is due to inflation. However, have you ever wondered, why do we have inflation? As a consumer, wouldn’t you want prices to go down instead of up (deflation)? What’s wrong with having deflation?
The reality is that central governments, including our own, do not like deflation. In fact, they actually WANT inflation! Why is that? Why diminish the purchasing power of the dollar? There is a very simple reason: Debt. The U.S. national debt recently passed $26 trillion. In case you were wondering how many zeros or what that looks like: $26,000,000,000,000.
You might be thinking, how does the national debt fit into inflation? As an illustration, imagine debt as a massive black hole. Central governments and central banks (i.e. The Federal Reserve) use inflation to shrink the size of that black hole.
A real-world example of this would be the U.S. Treasury issuing a bond for $1,000. They borrow $1,000 from you and will pay you back that sum in one year. Generally, the dollar gets hit with 4% of inflation annually. When the U.S. treasury pays you back, you receive the “$1,000”, but because of inflation, it only has $960 of buying power since the dollar lost 4% of its value. At the end of the day, inflation makes it cheaper to service debt. However, in a deflationary period, using the above example, instead of losing 4% to inflation 4% would be added to the sum you were to receive. Deflation makes it more expensive for the government to service debt.
While inflation may seem scary, there are ways to hedge yourself from the “invisible tax” and to keep your money from losing value. Having a well-diversified portfolio with an appropriate asset allocation (mix of investments like stocks and bonds) can help you achieve your financial goals. That asset allocation is based on your risk tolerance for the fluctuations in the stock
market. Historically, stocks have generally outpaced inflation, while bonds have generally been used to keep your money safe from stock market volatility. Finding that perfect mix that meets your needs is the key for long-term success. At ElderAdo Financial, our advisers can help you invest to protect against inflation, using an appropriate asset allocation for your stage of life and risk tolerance.