Inflation and Your Money
We’ve all seen the headlines about inflation retreating from its highs during the COVID pandemic, and lately the current annual inflation rate is near 3%, yet many consumers wonder: “If that’s the official inflation rate, why do my bills and other costs seem so much higher than last year?”
Many of us ask ourselves that question. The problem is that when the government reports inflation, it does so for a basket of goods, and some elements of that basket, like transportation, may be much higher than the average rate reported. That can explain why your home heating bill is 15% higher than last year, while average inflation is hovering between 2% and 3%.
But besides affecting the price of goods and services you pay for regularly, inflation can also affect your investments.
What is inflation?
Inflation is defined as an upward movement in the average level of prices. Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) to track these fluctuations.
It was developed from detailed expenditure information provided by families and individuals on purchases made in the following categories: food and beverages, housing, apparel, transportation, medical care, recreation, education, communication and other goods and services.
The CPI is a basket of goods, and your basket may not reflect the index’s basket. While it is the most used indicator of inflation, the CPI has come under scrutiny. For example, the CPI rose 2.4% over the 12 months ending February 2026, holding steady from the 2.4% rate reported in January.
Core inflation (excluding food and energy) increased 2.5% over the same period, indicating a stabilization in overall price growth. However, a closer look at the report shows movement in prices on a more detailed level. Motor vehicle maintenance and repair services, for example, rose 5.6% during those 12 months.
The effect on your investments
As inflation rises and falls, it can have the following effects on your investments and purchasing power:
1. Inflation reduces the real rate of return on investments. For example, if an investment earned 6% during a 12-month period and inflation averaged 1.5% over that time, the investment’s real rate of return would have been 4.5%. If taxes are considered, the real rate of return may be reduced even further.
2. Inflation puts purchasing power at risk. When prices rise, if you are on a fixed income, the money you have will cover fewer goods and services.
3. Inflation can influence Federal Reserve interest rate decisions. If the Fed wants to control inflation, it has various methods for reducing the amount of money in circulation. The most common way the Fed does that is to raise interest rates. As the logic goes, if interest rates rise, people and businesses will pull back on their spending, which in turn can reduce inflation. Also, if you are planning on taking out a loan, a higher inflation rate means you’ll have higher payments than if you take it out when rates were lower.
Seek out a trusted professional
When inflation is low, it’s easy to overlook how rising prices are affecting a household budget. On the other hand, when inflation is high, it may be tempting to make more sweeping changes in response to increasing prices.
The best approach may be to reach out to your financial professional to help you develop a sound investment strategy that takes both scenarios into account.