The Inflation Factor: How Cost Increases Impact You and Your Finances

The Inflation Factor: How Cost  Increases Impact You and Your Finances

Everyone is feeling the effects of a major inflation surge as of late, largely due in part to product shortages and global supply chain issues as a result of the COVID-19 pandemic. But what exactly does this mean and what can you do to better protect your wealth? Don’t panic — the more you understand, the easier it will be to safeguard your assets during uncertain times.

What is inflation?

As stated by the International Monetary Fund, inflation is the rate of increase in prices over a given period of time. The cost of living is often measured by how high inflation has gotten because it directly affects the price you pay for goods and services. For example, consider the price of a house 40 years ago compared to today’s cost. Due to the aforementioned supply chain problems, alongside the ongoing war in Ukraine, inflation is currently the highest it’s been in decades.

According to the Bureau of Labor and Statistics, the buying power of $100,000 in August 1982 equates to $303,143 of buying power as of August 2022 — this is the impact inflation has on your spending. The most important question is, can the income you make now cover your personal cost of living?

What’s the Federal Reserve?

The Federal Reserve System is the central bank of the United States. A major responsibility of this establishment is to stabilize the U.S. economy through monetary policy, such as raising interest rates and protecting the public via the administration of consumer laws and regulations.

Why is the Federal Reserve raising interest rates?

With U.S. inflation at its highest levels since the early 1980s, the Federal Reserve is taking swift action to combat this problem. They’ve made their third consecutive 0.75% increase this year, bringing rates to as much as 3.25%, the highest they’ve been since the 2008 recession.

By making the decision to raise interest rates, it cools financing for big ticket items. In turn, this reduces the demand for high-cost items such as cars, houses, and business expansions, which can slow down inflation.

What does that mean for you? 

Buying a house or car (two major household expenses) will be more expensive, leading many folks to hold off on making those types of large purchases.  As of the last week of September, interest rates on mortgages rose to over 6.7%.  The last time we experienced convergence of all these economic conditions was in the late 1970s and early 1980s.

Large businesses will look to reduce expenses rather than expanding by hiring new staff, purchasing commercial real estate, or seeking out other business opportunities that may enhance growth. Spending will inevitably slow down as individuals and companies become more conscientious of managing their cash flow.

What can you do?

• Shore up your cash. Focus on building your savings. Strive to save enough money to cover 6 to 12 months of household expenses. During inflationary periods, it is crucial to have cash set aside in the event of job loss. With each raise, promotion, and cost of living increase, add a bit more to your savings and minimize lifestyle creep.
• Monitor your spending. In much the same manner as businesses, look at ways to reduce household spending. It is a good idea to review your expenditures once a year. Make it a habit to review your household cash flow to stay on top of your spending.
• Review your investments. When the stock market is experiencing volatility, dividend paying stocks and funds is a way to increase your assets beyond depending on just growth in the stock price. This is a good time to ensure there are bonds in your portfolio, such as I Bonds and TIPS. The I Bonds earn interest based on two things: a fixed and inflation rate. Then there are TIPS (Treasury Inflation-Protected Securities), where the principal adjusts to reflect changes in the Consumer Price Index (CPI), which measures the monthly change in prices paid by consumers. Thus, a rise in the CPI results in a rise in principal and coupon payment.
• Maximize tax efficiencies. Rebalance your investment accounts to capture gains. The investment gains can be minimized by selling investments with current losses. The result is a reduction in your capital gains tax. Another term is tax loss harvesting, which can potentially offset up to $3,000 of your ordinary income.  If you own real estate, you can look at doing a 1031 exchange, where you swap one real estate investment property for another that allows capital gains taxes to be deferred.

With the never-ending media chatter surrounding inflation, now is a good time to meet with your financial planner to discuss your personal needs and long-term goals. Most importantly, it helps to have someone who understands and can help address any emotions you may be experiencing regarding market volatility.  These conversations with a knowledgeable professional can be both educational and calming during times of uncertainty and emotional distress.

If anything in this article resonates with you and you need to add another smart woman to your team, don’t hesitate to reach out to schedule your 20-minute exploratory meeting.