If you’ve been to the grocery store recently, you may have noticed a considerable rise in prices. All of a sudden, the cost of bread, milk, eggs, meat and your overall weekly food bill has gone up. And it’s not just food; prices have increased across the board. Filling up at the gas station, buying holiday presents, eating at a restaurant, even your car insurance — everything costs a little bit more nowadays. It’s called inflation and it’s currently at the highest level it’s been in two decades.
But what is inflation? Is it good or bad? Why does it happen? And perhaps most importantly, how can you protect your money from the effects of inflation? This article will cover all of that and more.
The simplest way to explain inflation is the rate at which prices increase over a period of time. Another way to put it is the decline in purchasing power of a given currency. In other words, your hard-earned dollars don’t go quite as far as they used to, so you need to spend more to purchase the same goods and services. This rise in prices (or decline in currency value) is usually expressed as a percentage measuring the change in the annual prices of a basket of consumer goods in the Consumer Price Index (CPI).
It sure sounds bad, doesn’t it? A rise in prices can be a difficult to deal with—especially if you’re living on a fixed income. However, most economists agree that a moderate level of inflation is actually good because it stimulates the economy, encouraging spending, investing and growth. This is why the Bank of Canada aims for a 2% inflation rate per year. That’s considered the sweet spot. But if prices rise too fast (hyper-inflation) or decrease over time (deflation), it can be sign of economic turmoil.
There are many factors that can impact inflation, but the supply of money is usually at the root of it. In broad terms, increasing the supply of money, usually by the Bank of Canada printing money, decreases its value. It’s simple supply and demand—the more of something there is, the less valuable it is. It’s a complex ecosystem, but this can have several effects on the economy.
The first, called the Demand-Pull Effect, is when demand for goods and services exceeds production capacity. For example, there was recently a chip shortage which caused a slowdown in vehicle production, resulting in higher prices due to a shortage of vehicle supply.
Another is the Cost-Push Effect when rising production costs cause prices to go up. An example of this can be seen in the restaurant industry, where the costs of ingredients has risen causing them to subsequently raise their food prices.
And, finally, there’s what’s called Built-In Inflation. It’s when wages are increased to keep pace with the new higher cost of living. This, in turn, results in higher production costs and, ultimately, higher prices.
By now, you should understand the basics of inflation. The next step is to figure out how to deal with it. We know the value of our money is eroding in an inflationary market. So, how do we protect it? The key is to avoid cash and get your money into assets or investments. Here are a few to consider:
Whether you have $1 or $1 million, inflation affects everyone, so it’s important to have a strategy to help you preserve your hard-earned money. Hopefully, you’ve found some useful tips here. If you have any questions, your best bet is to speak with a professional wealth advisor who can help you make a plan tailored to your individual circumstances. Best of luck!