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As a first-time investor, the idea of inflation can be intimidating. Its impact on your investments can understandably cause you worry. It’s also normal to feel overwhelmed and unsure on what inflation means for you.

Inflation is a complicated concept that impacts all aspects of our financial lives. It affects the prices we pay for everyday goods to the returns we earn on our long term investments.

But worry not! This article will provide you an overview of inflation and its impact on your personal finances. We'll also explore how inflation impacts long term investing, and what you can do to protect your hard-earned money.

What is the definition of inflation?

In simple terms, inflation means that goods and services start to cost more money over time. This can be a problem for you because it can make your money worth less than it used to be. It can also be a big deal for your finances, especially if you're trying to save up or invest for the long haul.

The Australian Bureau of Statistics (ABS) uses the Consumer Price Index (CPI) to calculate inflation. CPI is a way of measuring how much stuff costs. It looks at the prices of a bunch of different things that people buy - like food, rent, and healthcare. It then calculates how much those prices have changed over time. This helps us figure out how much inflation there is.

Now, one of the ways the CPI does this is by using something called a "weighted median price." Basically, it means that the CPI looks at the prices of all the things people buy. But it pays more attention to the prices of the things that people buy more often.

The ABS updates the shopping basket to make sure it reflects what people are actually buying. By monitoring changes in the basket's price over time, we can get a good idea of how inflation is affecting the cost of living for the average Australian.

How does inflation affect the value of money?

Inflation reduces the value of money over time. This means you might not be able to get as many things as you used to with the same amount of money.

Let's say, for example, that a coffee cost $3 ten years ago, but now it costs $5. This increase in price is due to inflation. As a result, your money can't buy as much coffee as it used to. The same is true for all goods and services in the economy.

Also, inflation can mess with the returns on your investments. This makes it harder to reach your long term financial goals. Stick with us to know why and how this happens.

Inflation and the Big Bang Theory — are they related?

The Big Bang Theory explains how the whole universe started with a huge explosion and has been expanding ever since. Similarly, inflation is like a "bang" in the economy after which there is rapid growth.

Now, you might be wondering how inflation relates to the Big Bang's expansion. When an economy is growing fast, it can lead to an increase in demand for goods and services. This increase in demand can further lead to an increase in prices, which is inflation.

A "bang" (rapid growth) in the economy can also cause inflation due to an increase in aggregate demand (which we’ll get into in a while). Businesses may increase prices to maximise earnings when the demand for stuff increases. This can also cause an increase in prices throughout the economy, leading to inflation.

But it's important to note an economy's rapid growth does not cause all inflation. Now, let's explore the different factors that affect this economic occurrence.

What causes inflation?

"What, then, mainly contributes to inflation?", you may ask. Well, it all boils down to the basic principles of supply and demand. When there is too much demand for too little supply, prices go up.

This is known as aggregate demand. For example, everyone wants to buy the same product. But since there's only a limited supply of it, the price of that product will then increase.

In Australia, there are a few factors that mainly contribute to inflation. They are the cost of housing, education, healthcare, fuel, and transportation. When these prices go up, it can make it harder for people to buy things. This can further decrease the overall demand for goods and services (aggregate demand).

Another thing that can lead to inflation is the "inflation tax." This happens when the government prints more money to pay for things they need to spend money on. When there's more money in circulation, its value goes down, which makes things cost more. This is why you might notice that the price of things you buy goes up over time.

Inflation can also relate to recession. Recession is when the economy slows down, causing lower demand for goods and services. This can lead to lower prices and decrease the value of money over time (deflation). But when the economy is growing quickly, there can be too much demand for stuff, causing inflation.

How do we fight inflation?

Now, let's talk about how we could win against inflation. The Reserve Bank of Australia (RBA) handles monetary policy. It has the power to adjust the interest rate, which can help control the amount of money in circulation.

So, if the RBA increases interest rates, borrowing money will become more costly. This will then reduce the amount of money floating around in the economy, which can help slow down spending and reduce inflation.

Another way to fight inflation is through the use of price indexes. These indexes measure the change in prices for goods and services over time. By keeping track of these changes, policymakers can decide the behaviour of inflation. Afterward, they can make decisions about monetary policy accordingly.

President Biden on measures to fight inflation

Recently, there has been talk about US President Biden's plan to fight inflation. Since the US and Australian economies are connected, the President’s inflation policies might impact Australia.

As major trade partners, any significant changes in the US economy can affect the global economy, which includes Australia. So, it pays to keep an eye out on any US policy changes because of its potential effects on the Australian economy.

President Biden’s plan to fight inflation makes use of clean energy tax, energy tax credits, and carbon capture investments. These measures are meant to create union jobs and care for the environment by reducing greenhouse gas emissions.

For instance, there's this new proposed bill called the Inflation Reduction Act. The bill tries to make sure companies pay their fair share of taxes. Plus, it promotes more union jobs and energy efficient initiatives, such as carbon capture and clean energy tax credits. The idea is that this bill will help reduce inflation and make the tax code more fair for the average person.

The Inflation Reduction Act could also to lower prescription drug costs. This is a big deal because of how much healthcare costs these days. So if we can bring down the cost of prescription drugs, the demand for healthcare could decrease. This could have a positive effect on inflation.

But, it's important to note that the impact of this policy on inflation is not yet clear and will depend on a variety of factors.

Finally, let's talk about the role of the Federal Reserve in setting inflation expectations. The Federal Reserve is in charge of making sure prices are stable and keeping inflation in check.

To do this, they set inflation rates. They also make decisions about how to handle money based on actual inflation rates. By setting clear inflation expectations, the Federal Reserve can stop inflation from getting out of control.

What impact is inflation currently having on everyday Australians?

If you're new to investing in Australia, you might want to know about inflation and how it can affect your money. The current inflation rate in Australia, as measured by the Consumer Price Index (CPI), was 7.4% as of January 2023. Although this is lower than the 8.4% rise in December 2022, it is the second-highest annual increase since 2018.

There are a range of reasons for this - like supply chain disturbances and increased demand for goods and services.

Things like food, housing, and energy can become more expensive because of inflation. For example, fresh fruit costs have gone up 18.1% in the past year. Electricity has increased by 10.8%, and rent went up 3.3% in March 2022 alone.

Is inflation good or bad to the economy?

So, whether inflation is good or bad to the economy is a bit complicated. Some inflation can be good, as it can encourage spending and investment. It can also be a sign of a growing economy. But too much inflation can be bad because it makes your money worth less. Over time, this can hurt the savings of regular Australians.

What is Inflation 1?

Let’s look into Inflation 1, for instance. Inflation 1 is when prices go up by 1% in the economy. This is usually a good sign that the economy is booming and people are spending a lot of money. That means businesses are doing well, and the economy is growing. Inflation 1 can also mean that people are earning more money and have more buying power.

But inflation 1 can also lead to higher interest rates, which can impact investments. The Reserve Bank of Australia (RBA) might crank up the interest rates to battle inflation. This can make it more expensive for businesses to borrow money. People may also think twice before spending their money. Higher interest rates can also cause investments, such as bonds, to lose value.

All in all, inflation is a normal part of the economy. And having a little bit of inflation can be a good thing for economic growth. The RBA has set a target of 2-3% inflation per year, which is healthy for economic growth. This means that prices are increasing, but not so rapidly that it negatively affects the economy.

As a first-time investor, it's important to stay informed about inflation and its impact on the economy. This will help you focus on your priorities as a long term investor and protect your wealth over time.

What effect does inflation have on long term investing?

Now, we bet you’re wondering how inflation can affect your investments over time. Inflation means that prices of goods and services go up over time, making your money worth less. This means that if your investments aren't growing faster than the inflation rate, you might actually lose money over time.

Investing in times of inflation

Investing during inflation can be a little tricky, but this doesn’t mean that it’s impossible. Below, we'll share some ways how long term investors might invest during periods of inflation:

1.Consider investing in inflation-protected securities . These products are made to change their returns based on the inflation rate.

For example, inflation-linked bonds, also called Treasury Indexed Bonds (TIBs), are government-issued bonds. They pay a fixed interest rate and an extra return based on the inflation rate.

If the inflation rate goes up, the extra return also goes up. This helps protect your investments from the harm caused by inflation.

2. Diversify your portfolio by investing in a variety of assets . When you choose what to invest in, think about how inflation might affect it.

For example, shares can go up and down in value more, but they could grow more over a long time. Bonds are usually more stable, but they might not grow as much.

To protect your investments from inflation, look into in assets that have a history of growing faster than the inflation rate. Real estate and shares are examples of such assets. But, it is important to note that past performance isn't an indicator of future gains.

3.Consider reviewing and adjusting your investment portfolio . This is to make sure that your portfolio matches your financial goals and risk tolerance . Inflation rates can vary over time. This means different investment strategies may perform better in different market conditions.

So, it's important to review your portfolio and make changes as needed to avoid having too much money in one kind of investment.

For example, if you're comfortable taking more risks, you may want to put more of your money into shares. But if you have a lower risk tolerance, you might want to invest more in bonds or other kinds of investments that have a fixed return.

You're not alone in feeling that inflation is an intimidating concept. But understanding how inflation can affect your investments is important. This can help you can make better decisions to protect your financial future.

Investing always carries some level of risk, especially during inflation. But remember there are strategies you can use to mitigate those risks. By doing your research and staying informed, you are now one important step towards securing your financial future.

Happy investing!