For consumers, inflation can mean stretching a static paycheck even further, but for investors, inflation can mean continued profit as they add to their retirement portfolio.
Inflation is defined as a sustained increase in the price of goods and services. In an inflationary environment, a gallon of milk that once cost $3 may now cost $4. Over time, inflation erodes the value of a nation’s currency. There are a variety of factors that influence inflation and arguments about its root cause.
How Can Inflation Be Good For The Economy?
In economics, inflation is a quantitative measure—one of quantity over quality—of the speed at which the average costs for a standardized basket of goods increases over a specific period. Inflation measures the spending power of currency and most often will appear as a percentage.
Climbing prices are bad news for consumers, as it takes an ever-increasing amount of money to purchase the same basket of goods and services year after year. This concept is known as purchasing power.
A nation’s monetary authority—such as a central bank—will work to keep the rate of inflation within a boundary that keeps the economy running and encourages growth. Some level of inflation is necessary as it promotes spending which helps national economic growth. The most common measurement tools used to rank inflation are the Consumer Price Index (CPI), and the Producer Price Index (PPI):
- CPI measures the weighted average a consumer pays for a standardized group of goods and is reported monthly by the Bureau of Labor Statistics (BLS). CPI measures finished products.
- PPI is a weighted average of prices for domestic producers at the wholesale level of production. It is also reported monthly by the BLS. PPI measures good at any stage along the production and output line.
Some nations will use WPI—which works in the same manner as does CPI but measures a basket used on the retail level—but the U.S. prefers to use PPI to measure inflationary pressures on businesses.
Many different factors contribute to rising prices. When the overall demand for goods build, supply prices will rise. Increases in the cost of production—due to everything from growth in the cost labor to rises in the cost of raw commodities. Most consumers view inflation as an adverse situation. However, inflation does have a positive side when looked at from an investment standpoint.
- Several asset classes perform well in inflationary environments.
- Tangible assets, like real estate and commodities, have historically been seen as inflation hedges.
- Some specialized securities can maintain a portfolio’s buying power including certain sector stocks, inflation-indexed bonds, and securitized debt.
- Inflation-sensitive investments are accessed in a variety of ways as both direct and indirect investments.
Real estate is a popular choice not only because rising prices increase the resale value of the property over time, but because real estate can also be used to generate rental income. Just as the value of the property rises with inflation, the amount tenants pay in rent can increase over time.
These increases let the owner generate income through an investment property and helps them keep pace with the general rise in prices across the economy. Real estate investment includes direct ownership of property and indirect investment in securities, like a real estate investment trust (REIT).
When a currency is having problems—as it does when inflation climbs and decreases its buying power—investors might also turn to tangible assets.
For centuries, the leading haven has been gold—and, to a lesser extent, other precious metals. Investors tend to go for the gold during inflationary times, causing its price to rise on global markets. Gold can also be purchased directly or indirectly. You can put a box of bullion or coins under your bed if a direct purchase suits your fancy, or you can invest in the stock of a company involved in the gold mining business. You can also opt to invest in a mutual fund or exchange traded fund (ETF) that specializes in gold.