How to Make Inflation Work For You
It’s been nearly three decades in the making, but it appears inflation is finally here.
The prices of most items are increasing significantly faster than they have been: In April, the Consumer Price Index rose 4.2% year over year, which is more than double the long-term inflation target from the Federal Reserve.
Inflation is still nothing to fear … at this point. However, you can be forgiven if you’ve been scared by the talking heads on TV yelling that the dollar is doomed. After all, nobody wants to pay for bread with wheelbarrows of worthless dollars.
However, these inflation scaremongers have been persistently overstating the risk for years, and it’s extremely unlikely that the United States would ever reach a bread/wheelbarrow inflation situation.
In fact, we’ve had the opposite problem over the past decade: too little inflation. Since 2010, the Consumer Price Index (CPI) has persistently lagged behind the Fed’s 2% target inflation rate. While this might initially sound like a good thing (who doesn’t want lower prices?) deflation is an even scarier problem.
(The risk is a deflationary spiral: When prices drop, consumers hold off on buying stuff because they think prices will keep dropping and they’ll get a better deal later, so businesses hold off production to address declining demand, layoffs ensue, employees become poorer and cannot buy goods, and prices continue to spiral downward. For those reasons, it’s why the Fed strives to keep long-term inflation at 2% and why moderate inflation is good!)
But anyway, inflation is upon us, and consumers and investors should think about it when running their financial affairs.
Here at Millennial Money, we believe you should run your financial affairs like a prudent business owner and pay close attention to your balance sheet (what you owe versus what you own) and your monthly cash flow. These are always critical but even more so during an inflationary economy.
Here are five steps you can take to make inflation work for you.
1. Check Your Credit Card Interest Rate
If you’re a homeowner, one positive thing about unexpected inflation is that it helps transfer wealth from lenders to borrowers.
Conceptually, it’s easier to understand this phenomenon when you understand that your debt was issued in past dollars (time of transaction) and you’re paying it back in today’s dollars. Because of that, inflation – and the salary increases it produces – benefits borrowers.
But inflation isn’t good for all borrowers. In fact, inflation is negative for borrowers of variable-rate debt. That’s because inflation gets quickly integrated into the interest rate, and the variable (higher) rate will then be paid by the borrower. Interest rates are likely on their way up as inflation takes hold, and consumers would be wise to investigate locking in any debt into fixed rates now.
If you’re thinking you don’t have any variable rate debt, think again. Despite appearing to be fixed, many credit cards have a variable rate structure. The reason they are assumed to be fixed is because the indexes they base rates off have remained low.
Therefore, pay close attention to any change in terms for your credit card companies. That said, it’s important to remember the best way to convert variable interest rates to fixed interest rates: Pay them off entirely, because a zero balance equals a zero-interest rate.
And even if you do have fixed rate credit cards, you’re not out of the woods entirely as many credit card companies have snuck in lending terms that allow them to change how they calculate and charge interest at their discretion and only allow you to opt out by closing the account.
2. Take Care of Your Big-Ticket Stuff
Most failing businesses have a key trait in common: deferred maintenance. It’s the cumulative effect of years of delaying service and underinvesting in the assets of their balance sheet. In many cases, the lifespan of critical equipment, buildings, and machines could have been significantly extended if normal and routine maintenance had been applied. (To quote your mom, “an ounce of prevention is worth a pound of cure.”)
It’s not just businesses, however. On a personal level, you don’t have to be a financial genius to notice how sellers these days have the upper hand in negotiations for homes, cars, or even repair services. Extending the functional life of your large assets and allowing yourself to make major purchases on your own terms is a win-win.
Even little updates help. According to the government site Fuel Economy, you can improve your gas mileage up to 3% by keeping your tires properly inflated and save on tire wear-and-tear in the process. While this certainly won’t counteract the effect of significant inflation, it does help cushion gas price increases with very little effort on your part.
3. Rethink Your “Raise”
Have you gotten a raise recently? It might not help you as much as you think.
Many employers used to provide two pay increases per year: one based on cost of living (hello, inflation) and one based on individual and company performance. Lately, a lot of companies have just been awarding one single, comprehensive raise per year. For years, the customary 3% raise was adequate to cover inflation while providing a minor performance-based raise.
But … the CPI rose 4.2% year over year in April.
So if your raise is less than the broad inflation rate (like it would be with the 3% example above), your living standards will decline despite receiving a higher paycheck.
It looks as if this is going on at a lot of companies that went into cash-preservation mode last year and have not provided any significant raises this year while inflation rages.
At the same time, many companies are paying top-dollar for new employees. The opportunity here for many workers is rather easy: Use this newfound power to see if your skill set and sales price is now worth more to new employers.
Remember, you’re selling your labor, so you should view this no differently than companies like Procter and Gamble that have recently raised the cost of their products due to higher inflation. In this environment, it’s worth exploring and testing the market for your talent.
4. Protect Your Investment Portfolio
Remember from earlier how above-average inflation transfers wealth away from lenders to borrowers?
Well, if you have any fixed-income investments like bonds, you are assuming the role as the lender. Any increase in inflation and the Fed’s response (eventually raising rates on new debt) will lead to lower prices for existing debt in your investing portfolio.
So what can you do to include fixed-income assets in your portfolio but still earn some money?
Historically, the asset classes considered best for an inflationary environment — besides stocks — are Treasury Inflation-Protected Securities (TIPS), real estate and real estate investment trusts (REITs), and precious metals like gold. Theoretically, cryptocurrencies with fixed total circulating supplies like bitcoin should be able to serve as a hedge against inflation but have other risk factors that will make them more volatile than traditional investments.
A word of caution on stocks: A stock is nothing more than ownership in an underlying business. Not all companies are able to pass along inflation to their customers, like if they’re in a competitive industry or don’t have market leadership. Earlier we wrote about three investments we liked for inflation with one popular company that has been able to raise its prices for more than a decade.
5. Make a Post-Pandemic Budget
Many Americans were surprised to see that they had extra cash during the pandemic. In addition to a few rounds of stimulus checks, there was something Goldman Sachs called “forced savings,” essentially the money Americans saved by not being able to go to the movies, take vacations, and even by not having to commute to work (and spending $8 on crappy sandwiches at the lunch place across from the office). Even when Americans did spend, it was often on lower-cost activities, such as camping locally.
At the same time, Americans did spend more on stay-at-home services like streaming video and those annoying-but-possibly-worth-it Instacart delivery fees.
Perhaps there’s a way to split the difference in this post-pandemic world: Set a new budget incorporating some of the savings lessons from the past year, and while you’re at it, cancel a few of your streaming services (whose subscription costs are probably gonna rise real soon).
A few other examples of taking a “best of both worlds” approach:
- Pack lunch when you return to the office
- Exchange one high-cost vacation for a return to a campsite (particularly this summer when travel prices are impacted by significant demand)
Cutting back on your pandemic-era services as the economy starts to reopen should help keep your personal balance sheet in order.
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