How Inflation Affects You and Your Portfolio

By Rory O'Sullivan, CFP®

Inflation is at a 40 year high and is impacting everything from wages, to gas and grocery prices and interest rates; which in turn creates market volatility. To understand how inflation affects you in addition to rising prices, it’s best to put it into context.

In the first quarter of 2022, fuel and used car prices are up 40 percent over last year and the Consumer Price Index (CPI) shows inflation is at its highest since 1980. In order to fight inflation, the Federal Reserve is planning to use one primary tool: interest rates. Increasing interest rates encourages consumers to save more because they are able to benefit from the higher rates. This decreases overall spending and slows down the economy which decreases inflation.

A driver of potential volatility related to increased interest rates is the fear of the unknown: How many interest rate hikes are we expecting? How big will they be? A key part of how inflation impacts the market and rates in general, is the anticipation of what might happen versus the reality. Historically, rate hikes have been a quarter to half a percent and the uncertainty of how quickly the Fed will increase rates concerns the market. As of March 16, 2022 the Fed announced a .25 percent rate hike with the intention of six additional increases throughout the year.

Inflation will also affect different parts of the market in different ways. The best thing to do is ensure that your portfolio is well balanced and diversified across sectors. For example, growth companies like Netflix, Amazon, and Microsoft may face headwinds in an inflationary market because their value is largely driven by future earnings. Value companies such as oil, financials and airlines typically perform better in an inflationary market as their value is more closely tied to current earnings.

Inflation has a very scary connotation but it’s not always bad; it all depends on how quickly it is increasing. Moderate inflation can raise wages and create job growth; it is a healthy part of an expanding economy. With factors such as supply chain difficulties and pent up demand leading the way, inflation has outgrown this healthy stage. The goal is that the Fed will be able to use interest rates to help slow down the price increases to create a sense of stability. In the meantime, be sure to speak with your advisor to ensure your portfolio is well-balanced and you are prepared for the ongoing volatility.

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, Certified Financial Planner™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Any opinions are those of Rory O’Sullivan, CFP and not necessarily those of RJFS or Raymond James. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.