Recent social and political instability and the chaos of the pandemic have caused 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. Sure, it’s interesting to learn about the theory, but that doesn’t really help you understand how inflation affects you or what you need to do to protect yourself financially.
Here at Everyday Money, we want you to know that inflation is real, and it is certainly affecting the current economy. However, it’s not all bad — there are some benefits that inflation can offer you. The key is to understand how to leverage those opportunities and defend against the potential risks at the same time.
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 your grandparents could pay 50 cents for a dozen eggs back in their day, 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 had to change over the last several years to account for higher rent, food, energy, transportation, and clothing prices.
Most economists believe that a small amount of inflation is actually a good thing. It’s when there is too much or too little inflation that 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.
Social Security COLA rates are typically around 2 percent. The Social Security COLA for 2021 was 1.3 percent. However, the SSA may be looking at a COLA increase of over 5 percent for 2022, which indicates just how significant inflation currently is.
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’ll actually be losing money compared to previous years. 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, it’s about the related challenges. Higher costs of everyday goods leave less money for saving, investing, and discretionary spending. However, there are two sides to the inflation coin, so there are actually 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 even make more money with your cash that sits in a high-yield savings or checking account.
Inflation tends to offer more opportunities to younger people. You’re not retired yet, so you’re in your prime earning years. You can use this time to plan out your investments, raise your income, and protect yourself against future inflation as much as possible.
How can you protect your finances and take advantage of inflation?
Inflation happens constantly. The rate of inflation fluctuates, and it’s high right now (mostly thanks to COVID). 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 you can to your investments: college savings, emergency fund, and retirement accounts. Buy a house if you can — no small ask, right? But we say this because the sooner you can become a homeowner, the more you can 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.
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.
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.
Plan ahead for 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.
A well-developed budget should account for inflation. If you aren’t managing your money with an eye toward the future, start by talking honestly with your partner about your finances. Then, use BudgetingBlocks™ to clearly visualize and allocate your money.