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Have you been following along with the financial headlines? You may have noticed a lot of buzz around a particular topic—yes, it’s inflation.
According to the Bureau of Labor Statistics, the Consumer Price Index (CPI) surged by 7.5% year over year (January 2021 to January 2022), marking the largest annual increase since 1982.
But before your palms start sweating too much, let’s take a step back and consider the following:
- What does inflation mean for your finances?
- Should you be worried about inflation?
- What steps can you take during an inflationary environment?
WHAT DOES INFLATION MEAN FOR YOUR FINANCES?
Generally speaking, inflation is a long-term consideration, since it is invariably happening. The total cost of goods and services in 2022 is dramatically higher than in 1922. Over the long term, you have to plan for inflation and it’s the main reason that you have to put your money to work; to protect your purchasing power. The cash you had in the bank in 2021 lost 7% to inflation which means your $100 can only buy $93 worth of those same goods in 2022.
In the short term, inflation may mean that living your normal life is a little more expensive than it used to be. Suddenly, it costs an extra dollar or two to fill up those cereal bowls, and with a few mouths to feed at home, this increase can add up in a hurry.
In the long term, inflation should be a part of your financial planning strategy. Your financial advisor should be hyper-aware of the impact of inflation. Given historical trends, it’s safe to assume that the cost of living will likely be much higher in retirement than it is now.
Everyday items you buy like groceries, housing, vehicles, etc. will likely cost more in 10+ years.
SHOULD YOU WORRY ABOUT INFLATION?
Inflation can come at you from a few different angles.
You’ve probably seen noticeable short-term spikes in inflation recently as production costs rise.
For example, during the global pandemic, the cost to produce many goods (i.e., food, construction supplies, and automobiles) became more expensive due to shortages in labor and raw materials. Those are the supply-side issues that have dominated during this pandemic.
These challenges can be managed as companies work through their bottlenecks and labor issues. Demand-side inflation can be more difficult to work through and is generally more of a concern for monetary policymakers.
WHAT IF THE FED RAISES INTEREST RATES?
Most Gen Xers have lived with interest rates between 12% and 0% and still survived, and continue to flourish. As inflation increases, the Federal Reserve will take steps to keep the economy from overheating. This is generally done by raising short-term interest rates which have hovered around 0% for over two years. Raising interest rates from 0% to 0.5% or 1% isn’t something we need to be afraid of, it’s just part of the realignment as the world gets back to “normal”.
However, those living on a fixed income need to realize that inflation is their number one enemy. Living on a fixed income with rising expenses is untenable over both the short and long term. Especially in a rising rate environment.
WHAT CAN YOU DO IN A HIGH INFLATION ENVIRONMENT?
Create a comprehensive investment plan that accounts for inflation, which is something we can help you do. As planners, we are always preparing for inflation and its impacts. Inflation has to be considered part of your plan, it’s been happening forever and it’s the cost of progress. Your goal is to maintain purchasing power while the prices of goods and services increase.
When you have a plan in place, you won’t be caught off guard. Instead of being reactionary you can be proactive and take advantage of the economic adjustments as the pandemic wanes.
You may be wondering what proactive steps you can take to combat the adverse effects of inflation. Here are a few ideas.
TAKE ADVANTAGE OF CHANGING CYCLES
Planning allows us to take advantage of opportunities during various market cycles. For instance, there’s never been a better time to downsize your home. It’s also a good time to revisit your debt situation, fixed-rate debts may be beneficial in inflationary environments.
Reconsider recurring expenses and large purchases. While there’s not much you can do about the price of gas or groceries, you have slightly more control over things like buying a new house, starting a home renovation, buying a car, etc. While you won’t be able to time every purchase ideally, be mindful of what’s going on in the market before jumping in with two feet.
INVESTING STRATEGY
Generally, investing in the stock market is an excellent way to combat inflation. Investing in the great companies of the world allows you to partner with the same companies that are passing on these price increases. Think oil stocks with crude at $130/barrel.
EXPLORE THE JOB MARKET
When inflation is high, there’s a good chance employers will pay a premium to retain or attract top-tier talent. After all, an increase in the cost of living increases the need for higher compensation across the board.
Use this to your advantage when searching for a new position. At the very least, make sure your current employer accounts for the spike in inflation when discussing your annual raise.
DON’T INFLATE YOUR CONCERNS
While inflation can be problematic in high doses, take heart, inflation is part of progress and you can learn to manage this risk while allowing your assets to grow. So turn off the TV and pause your Twitter account. We have seen this show before and as long as we plan accordingly, everything will work out in the long run.