Inflation is something most people notice in everyday life. From groceries and housing to insurance and travel, the cost of many goods and services can change over time. But inflation is more than simply seeing higher prices at the store. It can also affect how far your income and savings may go in the future.
What Is Inflation?
Inflation refers to a general increase in the prices of goods and services over time. As prices rise, the purchasing power of each dollar generally decreases. In other words, the same amount of money may purchase fewer goods and services in the future than it does today.
The Federal Reserve monitors several measures of inflation, including the Personal Consumption Expenditures (PCE) price index. The Federal Reserve has identified a 2% longer-run inflation rate as consistent with its price-stability goal.
Why Does Inflation Matter for Your Financial Plan?
Inflation can have a long-term impact on financial decisions. A retirement plan, for example, may need to account for the possibility that everyday expenses could be higher several years from now.
Consider a simple example: if your household currently spends $5,000 per month, future expenses could be higher even if your lifestyle stays relatively similar. Housing, healthcare, food, transportation and other costs may all change at different rates.
This is one reason financial planning often looks beyond today’s expenses and considers how purchasing power may change over time.
Inflation and Retirement
Inflation can be particularly important during retirement because many people rely on a combination of savings, investments and other sources of income to cover their expenses.
If the cost of living rises over a long retirement, maintaining purchasing power can become an important part of the overall financial conversation.
Rather than focusing only on a specific inflation number, it can be useful to periodically review whether your income, savings strategy and overall financial plan continue to align with your goals.
Inflation Does Not Affect Everyone the Same Way
Inflation is measured using broad baskets of goods and services, but individual households can experience changing costs differently.
For example, someone who spends a large portion of their budget on housing may experience rising expenses differently from someone who owns their home. Similarly, healthcare, transportation and travel costs can have different effects depending on a household’s circumstances.
The Consumer Price Index (CPI), published by the U.S. Bureau of Labor Statistics, measures the average change over time in prices paid by consumers for a representative basket of goods and services.
What Can You Do?
Inflation is one of many factors worth considering when reviewing a financial plan. Keeping track of spending, regularly reviewing long-term goals and understanding how changing prices could affect future expenses can help you make more informed financial decisions.
There is no single strategy that works for every individual or household. Your financial circumstances, goals, time horizon and tolerance for investment risk are all important considerations.
Looking Ahead
Inflation is a normal part of the economy, but its effects can become more significant over longer periods of time. Understanding inflation and its potential impact on purchasing power can help put today’s financial decisions into a longer-term perspective.
A thoughtful financial plan considers not only where you are today, but also how your financial needs may change over time.
This article is provided for educational and informational purposes only and should not be considered individualized investment, tax or financial advice. Individual circumstances vary, and readers should consult with their financial, tax or legal professionals regarding their specific situation.