Social and political instability have been hallmarks of post-pandemic America, and they have contributed to a significant rise in inflation. Chances are you’ve seen more than one news article discussing inflation with varying degrees of panic.
However, most conversations about inflation are academic rather than practical. And while it might be interesting to learn about the theory or this economic behavior, that knowledge doesn’t help you understand how inflation affects you or what you need to do to protect yourself financially.
Here at Guiding Wealth, we want to give you a better understanding of inflation and its effects (some of which can even be beneficial). Once you can see how inflation impacts the market and your personal finances, you can make more informed decisions about what to do with your money.
What Exactly Is Inflation?
Inflation is an economic concept that’s not always well-understood outside a university classroom. It seems like one of those things that the government is always arguing about and financial experts are constantly warning about, but what does it actually mean?
Basically, inflation means that the prices of goods and services are constantly increasing. It’s the reason that you can find old grocery flyers offering a dozen eggs for 50 cents, but you’re lucky to find a carton under $4.00 today.
Groceries are just one example — inflation has a huge impact on the cost of just about everything, from houses and gasoline to college tuition. You’ve probably noticed that your monthly budget has changed over the last several years to account for higher rent, food, utilities, transportation, and clothing prices.
Most economists believe that a small amount of inflation is actually a good thing. But too much or too little inflation is what can cause things can go wrong. Rapidly increasing or decreasing prices can harm the economy, so most world governments (including the U.S.) try to control inflation.
What Are the Challenges of Inflation?
Since inflation means an increase in the cost of essentials, it can wreak havoc on your budget, especially if your income is stagnant. Some companies provide cost-of-living adjustments (COLA) each year, and the Social Security Administration (SSA) also changes the amount of benefits payments to adapt to inflation.
The COLA for Social Security benefits gets announced each October. Social Security COLA rates are typically around 2 percent. But the SSA’s 2023 COLA was significantly higher — 3.2% — to account for high inflation.
Your employer may offer a cost-of-living raise every year, but it’s unlikely to be more than a few percent. Some companies don’t provide regular cost-of-living increases at all. If your income doesn’t increase at a rate that is at least equal to inflation, you essentially lose money compared to the previous year. You’ll have to pay more for goods and services, but your income won’t be enough to offset those higher expenses.
What Are the Potential Benefits of Inflation?
Most of the time when you hear about inflation, the focus is on the challenges it causes. Higher costs of everyday goods leave less money for saving, investing, and discretionary spending. However, there are two sides to the inflation coin, which means there are also some good things you can look for.
As inflation increases, so do interest rates. While this may be a downside if you are looking to buy a house, it’s a great thing for your investments! Higher interest rates mean that you get a better return on the money you’ve invested. When interest rates are high, you may be able to get a decent return on your cash that’s sitting in a high-yield savings or checking account.
Inflation tends to offer more opportunities to younger people. Those who are not retired yet are in their prime earning years. That phase of life is the time for individuals to plan out their investments, raise their income, and protect themselves against future inflation as much as possible.
Protecting Your Finances Against Inflation
Inflation happens constantly. The rate of inflation fluctuates, and it’s high right now. Since inflation will always affect your finances to a certain extent, it’s essential to do what you can to take advantage of its opportunities and protect yourself from its challenges.
You can use inflation to your advantage by contributing as much as possible to your investments, such as college savings, an emergency fund, and retirement accounts. It’s also important to work on building your income. Your salary should be increasing at least enough to match inflation. If it’s not, you may want to consider looking for a new job or even a full career change.
It might be a good time to buy a house if you can. That’s a big commitment, of course — and it’s not the right decision for everyone. But becoming a homeowner now can help you protect yourself against the higher real estate prices of the future. Even if you can’t buy a house right now, maybe you can make some changes to your budget to be able to buy a home in the next few years. And if buying a home isn’t one of your goals, that’s OK too.
Things will be more expensive in the future due to inflation, but there are some ways you can plan for that. For example, think about some of the big purchases you want to make in the next three to five years.
Maybe you want to buy a home, renovate the one you have, or replace your car. Perhaps you’re planning on expanding your family. By looking at these costs now and understanding how inflation could affect them over the next few years, you can adjust your budget to prepare for those higher prices.
Preparation Can Mitigate the Challenges of Inflation
You can’t stop inflation, but you can plan for it. By understanding how it works, you can leverage inflation to get a higher return on your investments. You can also protect yourself against the risks of inflation by working on increasing your income and making big purchases, like a house, sooner rather than later.
If you have some big financial dreams and aren’t sure how to make them a reality, we can help. Our Big Dreams Calculator walks you through each step of making a financial plan for big plans like buying a home or a car or having a baby. Download your Big Dreams Calculator for free, and start making progress toward your goals!