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Inflation is a Tax
Inflation will slice into the value of one’s investments in a very comparable way that taxes slice into one’s investment returns. Because of this, it is sometimes called a hidden tax. Inflation has averaged about three percent a year over the last ten years. Even though this does not sound like a very big number, take into consideration ten years of three percent yearly inflation means that $100,000 today will only be worth about $74,400 then. Inflation is certainly not a good thing for stocks and bonds. It increases the prices that companies have to compensate for everything from raw materials to labour and this simply presses on profits. Lower profits hurt stock prices. Inflation, or the belief of inflation, means higher interest rates are coming around. Bond prices suffer as investors demand higher coupon rates to keep up with the ones paid on newly issued bonds. Stock prices usually fall as investors look for business costs to increase. Inflation frequently causes investors to rebalance their portfolios. They tend to invest in variable rate deposits and money market securities when inflation is higher, taking money out of stocks and bonds. When inflation settles down, interest rates decline and investors then change back into stocks and bonds.
A couple of the biggest indicators of inflation are the consumer price index and producer price index. An annual increase of over three percent for either index frequently means that there will be higher interest rates since economists often see that high increase to be unsound. Other inflation indicators have to do with the level of bond yields, changes in credit spreads between high and lower quality bonds, and moves by the Federal Reserve to climb the fed funds rate.