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Inflation is a sustained rise in the costs of goods and services, which results in lower purchasing power. Learn how inflation works, how it is measured and how to hedge your portfolio against rising costs to protect your savings.
Inflation Explained
Inflation occurs when the economy experiences a rise in the prices of goods and services — including everything from eating out at restaurants to getting gas at the pump — over time. While the cost of specific items can increase or decrease significantly, inflation is typically measured broadly to present a picture of how prices are behaving in the country as a whole.
Understandably, inflation is a big concern for many Americans: Amid decades-high inflation in 2022, rising costs topped Americans’ list of the biggest problems facing the country, according to a Pew Research Center survey. Since then, there remains a gap between inflation and wages that a Bankrate analysis found likely won’t close until later this year.
Inflation affects consumers and businesses alike. When a business’ costs of materials and services rise, that cost is often passed onto the consumers, who then need higher wages to afford an increased cost of living.
The Federal Reserve’s target rate for inflation is 2%. But prices rose significantly amid the economy’s recovery from the Covid-19 pandemic, and inflation peaked at 9.1% in June 2022 — the highest level in four decades.
| Did You Know? |
| The current inflation rate is 3.1%, as of Feb. 16, 2024. The Federal Reserve hiked interest rates throughout much of the last two years in an effort to reduce the inflation rate back to 2%. |
There are three main types of inflation to be aware of: demand-pull, cost-push and built-in inflation.
- Demand-pull inflation occurs when demand for specific goods or services increases faster than the production capacity of the economy.
- Cost-push inflation occurs when there’s an increase in the cost of production.
Built-in inflation occurs when people expect future inflation to continue at similar levels to the current inflation rate, which can lead to workers demanding higher wages.
How Is Inflation Measured?
The consumer price index (CPI) is a key indicator used to measure inflation. The CPI, which is released by the Bureau of Labor Statistics, measures the average change over time for prices in specific consumer categories of goods and services. The commonly used “inflation rate” refers to how much prices increased over the last year.
| Did You Know? |
| CPI data is released monthly. Some categories, such as housing, health insurance and technology, have abnormal influences that make inflation difficult to accurately measure, according to CNBC. |
The producer price index (PPI) is another commonly used measure of inflation. While CPI measures price increases for consumers, PPI measures price hikes for producers.
How Inflation Affects Your Savings
Inflation eats away at your purchasing power, which is how much you can buy with a specific amount of money. That means when prices rise, your budget is likely feeling the sting. While many of us store our money in savings accounts that offer interest on our cash, it’s often not enough to keep up with rising prices.
As inflation rises, the buying power of your money decreases. For example, $500 in January 2000 has the same buying power as $913.56 in January 2024, according to the U.S. Bureau of Labor Statistics.
But there are ways to help ensure that your money doesn’t lose its value over time, even as prices rise.
Ways to Hedge Against Inflation
Strategically saving and investing is the key to hedging against inflation. This includes building a diversified portfolio of stocks, bonds and cash that can help your money grow and keep up with rising prices.
Consider the following investment and savings vehicles to hedge against inflation:
- Treasury Inflation-Protected Securities (TIPS): TIPS are a type of bond issued by the U.S. Treasury. This type of bond’s face value is pegged to the CPI, and adjusted as inflation rises.
- Stocks: The stock market returns an average annual return of around 10%. While it’s important to maintain a well-balanced portfolio with a wide variety of stocks, dividend stocks in particular can offer steady income during times of high inflation.
- High-yield savings accounts: Many high-yield savings accounts currently have interest rates above 5%, which is well over the current 3.1% inflation rate. While investing your money comes with the potential for higher returns, a high-yield savings account is a good place to keep money for short-term goals and emergencies.
Sources:
U.S. Bureau of Labor Statistics. (2024). CPI Inflation Calculator. Retrieved from https://www.bls.gov/data/inflation_calculator.htm
US Inflation Calculator. (2024). Current US Inflation Rates: 2000-2024. Retrieved from https://www.usinflationcalculator.com/inflation/current-inflation-rates/
Board of Governors of the Federal Reserve System. (2023, December 13). Federal Reserve Issues FOMC Statement. Retrieved from https://www.federalreserve.gov/newsevents/pressreleases/monetary20231213a.htm
U.S. Bureau of Labor Statistics. (2023, December). What Caused the High Inflation During the COVID-19 Period? Retrieved from https://www.bls.gov/opub/mlr/2023/beyond-bls/what-caused-the-high-inflation-during-the-covid-19-period.htm
CNBC. (2023, June 1). Measuring Inflation Can Be Tricky and Quirky. Here Are 3 Examples. Retrieved from https://www.cnbc.com/2023/06/01/how-inflation-is-measured-3-examples.html
