Understanding inflation
We’re sure you heard about inflation countless times, and, most probably, you already know what it is. However, most people don’t really seem to care as much as they should about it, even though it is one of the essential things in our lives as modern human beings.
Inflation matters and it should make you worry, because it affects you directly, every day, every second.
If you’re living in a market economy, then you most certainly notice that prices for goods and services are changing from time to time.
Some of them increase, while others decrease. When there is a considerable increase in prices, inflation occurs.
The reason this is extremely important is because you can no longer buy the same amount of products or services for the same money you used to pay for them.
If you were able to buy your favourite ice cream for $2 a few years ago, the same ice cream might cost $3,50 today. But the ice cream stayed the same. It has the same taste and the same amount. So what changed?
Well, the value of your money changed. $1 from a few years ago is worth less today. The value of your money has decreased.
This is what inflation does – it erodes the value of the currency over time.
Understanding CPI
How much do you pay every month for the things you consume the most often, products you use every day, like milk, eggs, bread, soap, water, even the shoes you wear and the subway you use to go to work?
All these goods and services are called a basket of items. And this an important indicator, because it is used to determine the inflation rate, comparing the price of the total basket in a given month compared with its price in the same month last year.
Why CPI Is Inaccurate
Even though the consumer price index – CPI – is widely used to measure inflation, it is considered flawed by more and more experts.
One reason why CPI is believed to show an inaccurate inflation rate is because it omits the effects of substitution, meaning the replacement of goods with others.
To give you an example, when their beloved bread gets more expensive, people tend to switch to cheaper bread, maybe opting for the store brand.
Or they might choose to buy regular gasoline instead of its premium version.
The CPI fails to represent these new choices of the consumers, as it continues to assume that people still buy the same amount of the same goods they used to buy before prices increased.
One other major reason for the inaccuracy of the CPI is that it tends to focus on urban consumers and gives less importance to the purchasing power of the people living in the suburban and rural areas.
How to Beat Inflation
Unfortunately, people like you and us cannot make inflation stop and cannot influence the decisions that are taken at governmental and even international level.
However, there are some things we can do to protect our hard earned money and even turn a profit. This is where the importance of investing steps in.
We know that the first thing you thought of is depositing your money into your savings account with your bank, and that’s an option a lot of people think about. But the interest rate the banks offer you is so low, that when you withdraw your money from the account, you don’t even come close to beating the inflation rate, since the money has already devalued.
This is why you must search for other options when it comes to investing smartly.
We suggest avoiding stashing cash under your mattress. $1 stashed under the mattress might mean $0.9 in just a few months, and even less in a few years. So this is not an option.
Invest the money you don’t intend to use in the near future – meaning 3 to 5 years – to avoid a decrease of their purchasing power.
The best strategy we recommend is diversifying your portfolio – meaning don’t put all your eggs in one basket.
Spread your investment into several asset classes – cash, real estate, stocks, etc.
This helps you increase your returns while also reducing the risks, such as those coming from inflation.
Real estate or gold, for example, tend to hold on to their value and provide pricing power, things which help resist inflation.
Another example would be stocks, and particularly stocks with a proven earnings growth and low debt.
When you decide to invest and you’re a beginner in the field, you might feel like you have no idea what you have to do and what type of investments you should choose.
So it’s very important to seek help and consulting from investment experts. Advice and a second opinion from a professional who has experience in the field, who has done it all and has had his ups and downs, and has managed to learn from past mistakes, is priceless.
It’s always better to learn from someone who has already made mistakes and knows how to avoid them than to start on your own and go through the same hardships by yourself.
Make sure you find the right person or team, who can put you on the right track and can offer you a diversified portfolio that is prepared for fluctuating economic times.
