The rate at which prices rise is referred to as inflation, and it’s an important factor for investors to keep in mind. If prices rise too quickly, the value of money decreases and people are unable to purchase as much with their income as they could before.
The government measures inflation by creating price indices that track overall price movements. The most well-known is the Consumer Price Index (CPI), which tracks the change in the cost of a basket of goods and services that typical consumers buy on a regular basis, like a loaf of bread or a bus ticket. Other price indices are more focused on specific categories of goods or services, such as energy and food, to provide more targeted measurements of inflation.
While there are many reasons why prices may increase, there are typically two main causes: “demand-pull” and supply-chain disruptions. The latter often occur as a result of natural disasters, conflict or other events that raise production costs and cause shortages. Both of these factors can lead to high inflation rates.
Investors should consider the effect of inflation when creating a savings plan and budget for financial goals. When the inflation rate rises, interest rates generally follow and erode the real purchasing power of saved money over time. Investing in assets that can retain their value or even rise with inflation, such as real estate or commodities, may help buffer the effects of higher prices. Additionally, investors should be wary of investments that depend on consumer spending or require a large debt load, as these types of assets may be more sensitive to rising inflation rates.