Outpacing Inflation

One of the few, if any, benefits of the recent recession is that, with so many people out of work and the rest of us feeling less secure regarding financial matters, consumer spending decreased. So what does that mean?

Like anything else in a market-driven economy, prices are determined in large part by supply and demand factors. It’s common sense, really – if demand for a product or service goes up, so does the price. Fortunately, the opposite is also true, so as the demand for, say flat screen TV’s decreases in a down economy, the prices for those TV’s also decreases. The “law of demand” tells us that, as prices decrease, we begin to buy more, and vice versa.

So for the past two years, fortunately inflation has not been too much a problem. In the U.S. we generally maintain a target range for inflation of 2-3% as part of a broader monetary policy. And while 2010 started the year at a rate of 2.6%, at the end of the year overall inflation, as measured by the consumer price index (CPI), was just over 1%. Think of the CPI as a market basket of goods and services that we buy every month. Like a shopping cart at the supermarket, every month we look at prices for the exact same items, compare them to the prior month, and the net index increase or decrease tells us the overall inflation rate.

If we are to be successful financially, of course, we must be able to outpace inflation. If we don’t and since our money will effectively buy less as a result, our financial “nest egg” will slowly but surely begin to shrink. So how do we do that? It certainly will not happen through a typical bank savings account, where record low interest rates and fees of all kinds cannot possibly outpace inflation. To do that we will need to take a risk and invest in stocks, mutual funds, and other investment vehicles. I’ll have more on this in later posts, but as you consider setting up an investment account for the first time, you will want to check out a previous entry on finding the right financial advisor. One of the few, if any, benefits of the recent recession is that, with so many people out of work and the rest of us feeling less secure regarding financial matters, consumer spending decreased. So what does that mean?

Like anything else in a market-driven economy, prices are determined in large part by supply and demand factors. It’s common sense, really – if demand for a product or service goes up, so does the price. Fortunately, the opposite is also true, so as the demand for, say flat screen TV’s decreases in a down economy, the prices for those TV’s also decreases. The “law of demand” tells us that, as prices decrease, we begin to buy more, and vice versa.

So for the past two years, fortunately inflation has not been too much a problem. In the U.S. we generally maintain a target range for inflation of 2-3% as part of a broader monetary policy. And while 2010 started the year at a rate of 2.6%, at the end of the year overall inflation, as measured by the consumer price index (CPI), was just over 1%. Think of the CPI as a market basket of goods and services that we buy every month. Like a shopping cart at the supermarket, every month we look at prices for the exact same items, compare them to the prior month, and the net index increase or decrease tells us the overall inflation rate.

If we are to be successful financially, of course, we must be able to outpace inflation. If we don’t and since our money will effectively buy less as a result, our financial “nest egg” will slowly but surely begin to shrink. So how do we do that? It certainly will not happen through a typical bank savings account, where record low interest rates and fees of all kinds cannot possibly outpace inflation. To do that we will need to take a risk and invest in stocks, mutual funds, and other investment vehicles. I’ll have more on this in later posts, but as you consider setting up an investment account for the first time, you will want to check out my September, 2010 entry on finding the right financial advisor.

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