With recession upon us, we must consider how inflation will affect us. At the time of writing this article, the inflation rate is about 8.6%, which is the highest since 1981. According to the Oxford dictionary, the definition of inflation is “a general increase in prices and fall in the purchasing value of money.” The concept of inflation is driven by market supply and demand. It reflects how many commercial products are on the market compared to the amount of the currency. This is further exacerbated when the currency is too widely available, and the purchasing power of such money declines. For example, a gallon of milk was 3.5 dollars in 2018, and now it is well over 5 dollars per gallon. In the face of the United States printing trillions of dollars, it is no wonder why we are facing such inflation. Products such as real estate, stocks, and even daily consumer products are meeting the highest increase in price since decades ago. This article will dive deep into why you should worry about inflation and how it can impact your life.
1. Inflation leads to increase interest rates.
To combat inflation, the Federal government often increases interest rates, limiting the amount of money that goes into riskier assets. These interest rates impact businesses, real estate, and different asset classes. This further discourages risky investments and decreases the demand for them. When the demand falls, there will also be a decrease in supply. To become more competitive, the market has to adjust its affordability by reducing its cost to the consumer. Ultimately, this leads to deflation. During the last recession in 2008, the interest rate increased from 5% to 6.3% to combat inflation. And when the recession was completed, it decreased to 4.6% in 2010. And the average length of a recession is about 2.5 years. Understanding this, we should focus on different asset classes, such as bonds. This allows you to make a fixed income for a certain period of time without losing money via the high-interest rates.
2. Inflation leads to market uncertainty.
It is no doubt that inflation leads to market uncertainty. The bear market in 2022 demonstrated that the SP500 dropped over 20% in 6 months. Because of the inflation, the consumers are now worried about basic demands such as gasoline, groceries, and food. We are hitting the headlines on running out of diapers, baby formulas, and gasoline. In combination with the Russian-Ukraine conflict and a new surge of COVDI19 infection, a recession is ultimately inevitable, and we should expect this to happen. Understanding this, we need to continue with our investments through dollar-cost-averaging. We also need to continue to build up our businesses and high-income skills. A recession is one of the best times to invest in yourself and continue with asset allocation. There have been 19 recessions in the history of the United States, and we continue to thrive as a nation with the highest stock market value. History has shown us repeatedly that if you continue to invest during a recession, you will most likely come out being on top.
3. Inflation lowers your purchasing power.
As mentioned before, inflation leads to the loss of purchasing power. Gone are the days when we would have 2 dollars per gallon of gasoline. And we suspect this will not come back at all due to the effect of inflation. Historically the price of daily items has never gone down. In combination with the lack of salary increases to combat inflation, we can quickly run into an income issue in the upcoming years. According to Forbes, the current salary increase in 2022 is only 3.4%, compared to the inflation rate of 8.6%. This means we will not be able to afford rent, food, gas, and utility. We need to learn to save effectively and stretch our dollars more than ever. Investing in a suitable asset class on top of a superb work ethic allows us to go through this inflation cycle quickly. In conclusion, inflation is an inevitable phenomenon that occurs every six to eight years. We should expect a federal interest rate increase to combat inflation. And we need to equip ourselves with knowledge and expect inflation to come down eventually.
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