Understanding Inflation And How To Protect Yourself From It - The Smartwealth Digest
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Understanding Inflation And How To Protect Yourself From It

One of the most talked-about topics of 2022 is inflation. In short, inflation means that there is a decline in purchasing power. In other words, a currency’s ability to purchase things decreases. Inflation is measured by factoring in the prices of different parts of the economy, ranging from fuel and food to rent and labor. Inflation has been rising recently, due to a combination of factors.

What Does Inflation Mean for the Economy?

Inflation can have multiple effects on the economy, but the most tangible is the decline in the currency’s purchasing power. As items become more expensive, each dollar can buy less, effectively meaning that it loses its value. When the dollar is worth less, so are savings, thus, any savings or money you have kept idle will lose their value over time.

This, if combined with increased costs but not increased salaries, can reduce the standard of living. People tend to respond by making purchases now rather than later to get ahead of further cost increases, which can drive inflation even further.

To battle inflation, the central bank will usually tighten monetary policy and increase interest rates on loans, making it more expensive to, for example, get a mortgage. This tends to drive people towards saving their money, to take advantage of those higher interest rates.

Differences Between Inflation During a Recession vs a Prospering Economy

In a prospering economy, the economy is usually growing at the same rate as inflation. There is no loss of purchasing power in theory, as there is more money in circulation while the money is also worth less. This is a desirable scenario with increased employment and rising living standards.

On the other hand, in a recession, economic growth can be much slower than the inflation rate. This makes the entire country poorer, as people can buy fewer things for their money. The stock market usually responds very negatively to this climate.

Inflation’s Impact on Stock Prices

Inflation can cause declines in the stock market, as people fear higher interest rates negatively impacting most companies. However, if the inflation is not incredibly high, the risk of higher interest rates is lower. And as previously mentioned, a prospering economy combined with inflation may not be a bad thing and therefore does not impact stock prices negatively. 

Since inflation causes saved money to lose its value, many people opt for investing instead, making stock prices rise. Generally speaking, unprofitable growth stocks are negatively impacted when inflation is high because of the interest rates, and value stocks tend to perform better. While inflation can cause you to lose money by decreasing the value of idle cash that is just sitting in the bank, investing can help you to grow your wealth beyond the rate of inflation and avoid this.

The Fed and Their Take on Inflation

There has been a lot of news lately regarding the US Federal Reserve’s goal to tackle inflation. Because of the current high inflation rates, they have recently hiked interest rates for the first time since 2018. This caused a decline in stock prices, as the higher interest rates have created much uncertainty in markets. However, the Fed’s other goal is to keep employment levels high, so their primary focus will be to cool down inflation without hurting the economy.

It is clear that inflation has its ups and downs. Currently, we are experiencing inflation that is not positive, which brings the question of what to do. To protect your savings from eroding, you should consider investing it. Regular investing in a robo-advisory such as SmartWealth can be a good approach, as it uses many different strategies to provide you with a diversified investment plan that matches your preferred risk levels. Sticking to this investment plan for the long term can better help protect the value of your money from inflation, volatility, and any other potential risks.

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