What is inflation? We hear people talk about it, but what does it really mean? Talk about inflation, and how it affects the stock market and prices of goods, are actually based on the Consumer Price Index.

“The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services,” according to the Bureau of Labor Statistics.

The CPI affects nearly all Americans because of the many ways it is used:

• As an economic indicator.
• As a deflator of other economic series.
• As a means of adjusting dollar values.

The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

Why does CPI matter?

• Payouts on inflation-protected investments like TIPS and Series I bonds are indexed directly to the CPI.
• Social security payments, pensions, and inflation-indexed annuities all rely on CPI data to determine their annual adjustments.
• The size of individual income tax brackets, personal exemptions, and the standard deduction are tied to movements in the CPI.
• Low inflation numbers (especially when they are much less than GDP growth) make the economy seem healthy.

The budgetary effect of any overestimate of changes in the cost of living highlights the possibility of a shift in the distribution of wealth. If the CPI has an upward bias, some federal programs would overcompensate for the effect of price changes on living standards, and wealth would be transferred from younger and future generations to current recipients of indexed federal programs-an effect that legislators may not have intended.

The U.S. Bureau of Labor Statistics measures two kinds of CPI statistics: CPI for urban wage earners and clerical workers (CPI-W), and the chained CPI for all urban consumers (C-CPI-U). Of the two types of CPI, the C-CPI-U is a better representation of the general public, because it accounts for about 87% of the population.

CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation.

Variations of the CPI are published monthly by the Bureau of Labor Statistics, where they track the prices consumer pay for goods and services. If the government detects an increase in the price consumer pay for these goods, it’s called inflation.

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As in all aspects of life, investment entails a healthy balance between taking risks and playing safe. In the investment world, there is such a thing as being too safe.

When you first entered the playing field, you were told to stay away from high risk stocks and put your money someplace safe. But as you reassess your portfolio years later and see very little change in your earnings, you wonder whether you would have been better off had you ignored the advice and taken the risk.

Do high risk stocks really live up to their name? The answer is yes. They are highly volatile and are potentially dangerous investments.

Handle short-term investments with a marksman’s precision. Selling them at the right moment, when their value is at its highest and just before it begins to drop, is both an art and a science.

With short term stocks, it’s possible to double or triple your investments in a very short time, but if you’re not careful you could end up losing your money.

Your long-term investment, on the other hand, is a sure-footed creature, but you won’t be able to enjoy its fruits until it matures, and that’s a very long time.

To come right to the point, the secret to a healthy investment is diversification.

A well planned portfolio with a healthy mixture of short- and long-term investments is the key to getting the most of your money.

Your short-term investments are intended to be ‘short-term’ and can’t carry you through the long haul. Your long-term investments, however, are meant to last for years — to grow slowly but steadily.

In a mixed portfolio, your short- and long-term investments can work together to ensure that you reap the fruits of your hard earned money.

The secret to a sound financial investment is to diversify your portfolio by spreading your risk thin among different investments.

Diversification involves carefully choosing the right group of investments so that each of these different assets can act as a buffer against losses in the others.

Under normal conditions this could slow or even stunt growth as this situation could hinder your investment from reaching its maximum potential. But market conditions aren’t always normal and diversification can become your savior when one or a couple of your stocks turn sour.

Let’s study the history of Bear Stearns a little bit. Having survived the two World Wars and the Great Depression, the company stood firm in its belief that specialization — not diversification — is the key to financial success. However, this prestigious investment bank all of sudden came crashing down, which caused turmoil in the financial world.

Why did this banking institution collapse? While its competitors diversified their holdings, Bears Stearns was a specialist and held on to only one type of investment — Collateral Mortgage Obligations.

CMOs were at that time considered a great investment when people still paid their mortgage bills. But hard times came and payments stopped, hitting specialist Bear Sterns the hardest.

There’s a lesson to be learned here: Don’t put all your eggs in one basket.

What you can do is allocate your assets. Divide your investment portfolio among different categories, such as stocks, bonds, and cash. As to which different combinations of assets your portfolio eventually holds is a matter of personal preference.

Good luck and happy investing.

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If you’re thinking about investing in an airline, think again. The flagging airline industry has been struggling to keep its wings above the clouds for nearly a decade now. Plagued mainly by rising fuel cost, airlines were forced to obtain credit from lenders and investors at exuberant rates.

The vicious cycle continues with the ever increasing oil prices and the sudden decline in value of the airlines’ badly-maintained collaterals. This resulted in credit crunch, where lenders and investors were forced to make it difficult for airlines to obtain financing. You see lenders do this by increasing interest rates and/or requiring additional collateral.

The airline industry has been ailing for years, but the big blow came during the 9/11, which almost literally shattered the industry to pieces, and has not recovered from that incident since.

Take the case of Delta Airlines Corp. and Northwest Airlines Corp., where both parties agreed to merge in a $3.63 billion stock deal. These two airline giants will pool in their resources together to obtain about a billion dollars in new revenue and savings just to survive the crunch. The credit crunch made raising revenues and financing more expensive, and the condition was made worse by the decline in consumer demand due to the weak economy.

Will the airline industry ever recover? Will the merger of Delta and Northwest save these companies from future decline? There have been a lot of things done to rehabilitate airlines in the recent past, but only a handful survived. Why? It’s because no one has direct control over oil prices. And how can you convince a frightened nation that it’s safe again to take the plane after that dreadful tragedy?

As an investor, you would want to put your money where it can safely grow, and investing in airlines is just not safe anymore.

Some authorities believe that the two airlines together could survive and become competitive even beyond the US. However, the risks are high and chances are, in the near future, the evil downward spiral would again occur. But who knows, maybe not.