Inflation has been hot through the first two quarters of 2022, and everyone has understood that it is affecting the market. But why do we even have inflation and what causes it? This is best explained in this graphic:
- When bank interest rates are low, people are more likely to borrow money
- When more money is in the hands of consumers, they use it to buy products and services like houses, cars, etc.
- When this occurs, demand for these products and services rise.
- When there is higher demand for products and services, prices rise.
- This is how inflation occurs and makes your money less valuable than before.
- Lastly, to try and settle inflation, the Federal reserve can raise interest rates, which causes an adverse cycle to bring demand and prices down.
One way to track inflation is by looking at the Consumer Price Index, or CPI. The Consumer Price Index is a measure of the average change over time in the prices paid by consumers in urban households for a basket of goods and services. Upward trends in CPI mean that there has been an increased change in prices, which would lead to increased adjustments in cost of living and income. As of June, the Consumer Price Index for All Urban Consumers (CPI-U) increased 9.1 percent over the last 12 months; the largest 12-month increase since 1981.
However, this is not to scare you off from investing because there is high inflation. It is so you can think about how a downturn in the market can be looked at with some positivity:
If you are younger investor, there may only be three prominent recessions that stick out in your mind: the 2001 dotcom bubble crash, the 2008 financial crisis, and the most recent Covid-19 crash. While these recessions were due to different circumstances, not every bear market leads to a technical recession. A bear market is commonly defined as a market drop of -20% from its peak, and there have been 10 of these instances in the S&P 500 since 1980. Even with that number of major declines over the last 40 years, this is the chart of the S&P 500 over that same time frame:
Warren Buffett has a famous quote for investors to be “fearful when others are greedy, and greedy when others are fearful”, which he said to a letter to investors in 1986. Going through bear markets is just part of the investing cycle. They have historically recovered each time and rewarded long term investors.
If you have a shorter time horizon, this is also not a time to panic. The last couple bear markets have had relatively quick recoveries, but historically can last anywhere from 2 months to multiple years. Here are some things you could do enhance your investment strategy during a bear market:
- If you are taking distributions, think about realigning the risk in your portfolio that fits your income needs now.
- Shift your mindset towards spending less and saving more. Focus on increasing your emergency funds and reconsider big purchases that may not be necessities.
- Do not time the market. Selling your positions thinking they may drop a few percent only to buy in a few months later is a difficult strategy. This could lead you to miss out on potential swings to the upside. No one can predict the bottom, so remembering to be a disciplined investor is important.
- Tax-Lost Harvesting when stock prices have fallen can take advantage of tax-saving strategies. Tax-Lost Harvesting can offset gains elsewhere or lower already existing unrealized gains that may have accumulated over years of investment.
- Consider Roth Conversions. Taking advantage of lower prices with Roth conversions could be beneficial to adding a tax-free component to your overall assets.
Everyone’s financial situation is different, and it be helpful to talk through big decisions or concerns with your advisor. Please feel free to reach out to Cheryl or Carter with any questions.