Have you noticed your grocery bill is higher? Your rent is now exceptionally high? Gas price is making you rethink your need for a car? This is because of inflation. March 2022 inflation rate increased 8.5% following a rise of 7.9% from February. Everything is more expensive. Some more than others. In order to achieve your financial goals in this type of economic environment, you need to be knowledgeable and strategic. Here are 3 things you should know about inflation and what you can do about it.
1. What Is Inflation?
Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country (imf.org). The government measures the cost of living by conducting household surveys. This data is tracked and expressed as a percentage of change over a certain period called the consumer price index (CPI). The CPI measure that we hear most frequently is Core CPI. This measurement is CPI excluding government set prices and volatile prices such as food and energy. To reflect modern behavior, government agencies will periodically change the items they track.
2. How Does Inflation Affect You Finances?
Higher inflation means higher prices for the same products that carries the same value. In fact, economists have reported a phenomenon called Shrinkflation. Shrinkflation occurs when product size decreases (shrink) but prices stay the same. In this case your per unit cost is actually higher than before. These higher prices will lead to a revision in your budget that could affect your long-term financial goals.
Less Discretionary Income
With higher prices comes less discretionary spending. This can directly impact your standard of living. Less discretionary income means less money to spend on the things you enjoy outside of your necessary bills. It also means you’re saving and investing less which impacts your wealth now and in the future. Inflation makes every dollar you earn worth less.
Lower Investment Returns
April’s stock market performance is reported to be one of the worst since 2008. This is because companies are reporting lower than expected earnings. Due to the COVID-19, supply chain issues, labor shortage and inflation, companies are also facing higher prices. In some cases, companies can pass it on to the consumer, but in others they have to absorb those costs. This lowers the company’s bottom line. If you’ve invested in the last 4 months, you’ll notice your returns are much lower than your returns over the same period last year.
3. How Do You Protect Against Inflation?
There are two ideal ways to protect yourself against inflation:
Make More Money
We have established that inflation lowers the value of a dollar. The most logical solution to this problem is to increase your income by at least the inflation rate. When your income increases by this rate, you’ll be able to maintain your standard of living and achieve your financial goals.
The US government is aware of the impact inflation has on their citizens. In an attempt to encourage investing in high inflation environments, they created inflation protected assets. These are special types of bonds ( e.g. TIPS & IBonds) where returns are adjusted for inflation and deflation. TIPS can be purchased through your brokerage firm for as little as $100. While IBonds are even more affordable at $25. Other smart investments include investing in real estate and mutual funds.
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However you choose to navigate this new inflationary environment, the more you know the better. These 3 things you need to know about inflation will further help you to do just that.
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