Inflation 101

Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.                      Sam Ewing, Author

With the global economy’s continued expansion, we could begin to hear more concerns voiced about rising inflation. But what does rising inflation really mean and how might it affect your daily life? On a basic level, inflation is simple to understand. As the cost of goods and services rise, the buying power of the dollar falls. However, we live in a complex world and inflation does not always work the way we might expect. Here we provide a brief look at current consumer dynamics and wages to help explain inflation and what might be in store for us.

Consumer Dynamics

Each month, the Bureau of Labor Statistics releases the Consumer Price Index (CPI), a measure that averages the cost of a representative basket of goods and services from urban areas around the country, and then reports the results as a percentage rise or fall. Essentially, it is a measure of inflation affecting the US economy.

The latest CPI numbers tell us that inflation over the past year (Jan 2017 – Jan 2018) is about 2.1%. The 2.1% reading is a compilation of prices of various services and products consumed throughout the economy. Of the many items monitored, a few stood out as rising faster in prices than the overall inflation rate. They include fruits and vegetables, eating out, energy, hospital services and auto insurance.

Inflation impacts consumers differently, with demographics and lifestyle being significant components. Typically, inflation for retiring individuals is very different than inflation for college students. Why? Lifestyle and daily needs are quite different for these two age groups. For example, the ongoing increases in medical and hospital service expenses are primarily a burden for seniors and retirees. On the other hand, the increase in auto insurance costs and transportation services tend to be more impactful on younger consumers who are still very mobile. However, of the various components that have risen faster than the overall inflation rate for the past year, essential items such as energy, fruits and vegetables tend to impact seniors and students similarly.

Higher Wages Offset By Higher Inflation

The average hourly earnings report from the Bureau of Labor Statistics for January 2018, the most recent available, showed a 2.9% increase from a year earlier. The average hourly pay for all employees in the U.S. rose from $25.99 in January 2017 to $26.74 in January 2018. The concern is that the increase in hourly wages is barely keeping up with inflation, which rose 2.1% over the same period.

Upon closer inspection, the wage report is not as inflationary as perceived since most of the gains noted within the data were in the form of bonuses and one time payments, and not permanent recurring increases indicative of structural wage inflation.

Government data is also revealing that the cost of things we like to buy, such as washing machines and TVs are starting to rise. And the cost of goods that we need to have, such as food, energy, and rent, are also on the rise. Economists expect that as consumer budgets start to get squeezed, then the demand for discretionary products will decrease. The companies that sell a service or product that is a “need” will have what economists deem as pricing power, or the ability to charge more and get away with it.

Inflation and Your Portfolio

Madison utilizes an “all weather” approach to portfolio construction which seeks to take into account potential inflationary issues, as well as other issues.  Our team has extensive experience working with, and educating clients on how a customized portfolio can help you reach your goals while seeking to mitigate the effects of inflation on your purchasing power.  We understand the art and science of asset allocation, asset location, and creating customized and diversified portfolios as we strive to generate competitive results while managing risk.

If you would like to learn more about how Madison is working to help its clients and friends navigate a rising rate and potentially inflationary environment, please contact us for a consultation.

Important Note: This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Madison Wealth Management does not provide tax, legal or accounting advice. © Madison Wealth Management 2018