As financial advisors, clients often come to us with various questions on GDP, unemployment, rates of interest, consumer consumption and the way these numbers can affect the market and their investments. I would like to be prepared and supply my clients with the most recent numbers and context to reply their questions.
Lately, customers are noticing the rising costs of a lot of their expenses: groceries and rent, to call just a few. Of course, they might be frustrated and switch to us to assist them understand what is occurring. Why is every thing dearer? What is causing record high inflation? How are the Federal Reserve’s rate of interest hikes helping to handle this problem?
Such discussions require that we’ve greater than just a fast statistic or two. There is a number of context we might have to fill in to elucidate the present situation. We might have to take a seat down and explain the various intervening correlations, connections and effects of rising prices. What is actually happening within the economy at once? How will central banks try to resolve the issue? Can you?
Here are just a few suggestions for approaching these conversations with customers:
1. Define inflation
First, it might probably be helpful to elucidate to clients what inflation is and why it is crucial in the long term. Simply put, inflation is the rise in the costs of products and services. In deflation, alternatively, these prices fall over time. Inflation subsequently increases the price of living in an economy. This implies that over time, extra money is required to buy the identical items and the buyer’s purchasing power decreases.
Of course, regular, increasing inflation is crucial for a healthy economy. Too low inflation indicates low demand for goods and services and might result in a possible economic slowdown. However, inflation also becomes an issue when it is simply too high. Left unchecked, persistently high inflation can slow the economy and erode savings. That’s why we’d like to work closely with our customers to assist them find ways to take care of their purchasing power over the long run.
2. Explain how we came
The Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics, is the predominant barometer of U.S. inflation. The CPI was largely unchanged in July from June after gas prices fell for 57 straight days. But year-on-year prices are up 8.5%. A predominant cause was food prices: they rose almost 11% in comparison with last 12 months. This is a burden for a lot of families.
Customers may ask: How did we even get up to now?
The causes of inflation vary, but they are often products of the economic principles of supply and demand. Although there are other variations, economists typically categorize inflation into two core concepts:
- Demand pull: Demand for goods and services is increasing, but supply will not be keeping pace.
- Cost boost: The supply of products and services decreases, however the demand for them doesn’t.
Today’s persistent inflation has no single cause. In fact, several aspects in the worldwide economy contribute to this. According to a study by the Federal Reserve Bank of San Francisco Supply aspects account for about half of the recent rise in inflation. What does that mean?
Supply chain issues resulted in shortages of products and materials. This was further exacerbated when many factories in China temporarily stopped production on account of the country’s zero-COVID policy. Meanwhile, trillions of dollars in stimulus from the U.S. government fueled a strong recovery from the economic crisis brought on by the pandemic and, in turn, led to an increase in income and demand. Record-low US unemployment and a good labor market fueled wage growth. Then the war between Russia and Ukraine reduced global supplies of oil, wheat and other raw materials.
3. Explain what the Fed’s rate hikes must do with this
Why and the way do rate of interest increases correlate with a discount in inflation? The Fed has the twin mandate of promoting maximum employment and stable prices. If it seems that inflation is pushing prices up too quickly, the Fed will raise rates of interest to attempt to curb inflation by increasing the price of borrowing (e.g. bank cards, mortgages, etc.). This in turn reduces demand, which may lead to lower prices.
But the Fed will even cut rates of interest if it desires to stimulate economic activity. For example, in 2008 the discount rate was set to zero. We were in a financial crisis – a extremely bad one. To stimulate consumer consumption and inject liquidity into the economy, the Fed lowered rates of interest so people could borrow to purchase goods and services, start businesses, or increase inventories. In theory, it really works like this: More consumption results in more spending, which results in more growth, more hiring, more paychecks cashed, and in turn more consumption.
By raising rates of interest today, the Fed wants to extend the price of borrowing. This tends to make people less willing to borrow and subsequently less willing to spend money. For example, a customer may resolve to buy a brand new home with a 3% mortgage, but a 5% mortgage may put it out of their price range. If rates of interest on savings accounts rise, more people might be encouraged to place their money within the bank.
The thought process goes something like this: Higher rates of interest mean a tighter and more limited money supply. Consumers will subsequently spend less. Higher rates of interest can “cool” the economic landscape. Going back to basic economic theory, less demand means lower prices.
4. Help customers manage the impact
Everyone has different circumstances, priorities and long-term goals. That’s why it is vital for our clients to have a long-term financial strategy that aligns with their personal goals. Inflation can impact every day spending, however it also impacts long-term planning. For this reason, we’d like to review their allocations with them usually.
Clients could also be wondering whether or not they should adjust their portfolio now. And the reality is, there isn’t a “right” answer for everybody. Inflation affects each sector in a different way. We have to confer with our clients, take a comprehensive have a look at their overall financial outlook and discuss where each asset class is heading.
What we do know is that diversified portfolios are inclined to perform best over time, whatever the inflation environment. We also know that clients need us, their advisors, when there may be uncertainty, and this 12 months definitely offers loads of that.
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Photo credit: ©Getty Images / Kinga Krzeminska
