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You connect to everyone else with the concept of money, either in payment or income. However, there is another term that relates you to everyone else and perhaps without you knowing (or maybe you do know): inflation.
Inflation has been more prevalent in recent news or in friendly conversations. However, you do not need to be attached to the news to be aware of inflation as it shows itself in everyday things you depend on, such as groceries, gasoline, and many other things.
Inflation also has been around for many years and will continue into the foreseeable future. As a result, there’s been a high interest via Google search for the term inflation, which began in late 2021 and continues to move up in 2022. Some of the most sought Google queries are “what is inflation,” “inflation 2022,” & “when will inflation go down.”
What is inflation?
The non-simple definition of inflation is when there is a decline in purchasing power. In simple terms, it is when the cost of something in the past costs more in the present time. For example, a pack of gum costs $0.05 in the 1940s; the same pack now costs around $2.
What causes inflation?
The increase of the money supply in the monetary system. Another way to see this is when the money authorities print or give away more money to individuals. Another form is borrowing money by having low-interest rates on loans and credit cards. Both factors of increasing the money supply and low-interest rates occur when the economy is in bad condition. Both forms help individuals spend to create growth in a slowing or bad economy.
When will inflation go down?
Inflation begins to calm down when the opposite occurs, such as less money introduced into the monetary system and increased interest rates. These factors happen when the economy is “running hot,” meaning that the economy is doing well, and everyone is buying things. Therefore, to slow down the economy and not create hyperinflation (when inflation gets out of control and this isn’t good), money is taken out of the system, and interest rates rise to curb spending.
5 Things to Be Aware Of
It is not fun when you work hard and earn a paycheck raise of 3%, yet inflation is twice as much; you are still upside down. So here are some things to be aware of during inflationary times.
1. Create a Budget
When simple everyday things start to cost more than usual, it creates a shock in your spending habits. It is an excellent time to ask yourself, “can I live without it during high inflationary times?” By creating a budget, you realize that most necessities are covered, and those things that need reduction are discretionary spending. One of the most common expenses is those on a monthly membership, such as streaming services to other apps. Having more than one starts to add up if you think about it. Cents add up quickly as much as dollars do.
If you currently have a budget, you are one step ahead. Although it is not “rocket science,” sometimes you may need assistance with creating a budget, or you would rather have a professional assist you with allocating your cash flow. Creating a budget, also known as Cash Flow Management, is one of the many different topics but is one of the most integral topics of a financial plan.
2. Credit Cards
Beware of those teaser rates expiring because interest rates are going up. You know those teaser rates to entice you to purchase high-priced items such as a new 65-inch LED high-definition television. However, if you have credit cards with a teaser rate of 0% interest, beware that these types of promotions have an expiration date. Depending on the credit card, some of these expiration dates are within days, months, or even years.
The key to most of these teaser rate credit cards is you must have a zero balance before the expiration date of the promotional interest rate. If you have a balance, you will incur backdated accrued interest on the balance, which means you will incur the entire interest from the first day you made a purchase to your account. Now you see that the television you purchased is starting to get expensive.
In an inflationary environment, interest rates rise. Most of these credit cards have variable interest rates meaning they fluctuate with the current interest rates. Refer to the cardmember agreement of your credit card to see how your interest rate calculation. You will also find within this table the fees associated with your card and what the interest rate will be if you fail to pay.
Making purchases is fun, but you realize that getting into debt and getting out of debt is not fun. Therefore, another topic within a financial plan is Debt Management which advises you on which obligations to pay off first based on the interest rate of the debt and any income tax ramifications.
Remember, debt is not an asset to you. It is a liability; therefore, it does not generate income but rather an expense, nor does it appreciate.
3. Variable Loans
Variable loans are like credit cards because they have variable interest rates meaning they fluctuate with the current interest rates. Most of these loans are from banks, and some of the most common variable loans are short-term loans, student loans, and even mortgages known as Adjustable-Rate Mortgages (ARM).
Variable loans are popular during low-interest-rate environments because the rate is much lower than the fixed rate. The rates are much lower than the fixed-rate because you, as the borrower, take on the risk of interest rates increasing. These types of loans may seem like they make sense, perhaps during the beginning of the loan and for a specific time the payment is within your budget. The drawback is that when interest rates rise, the loan payments do not fit your budget. The 2008 Financial Crisis originated from ARMs as borrowers could not pay their minimum mortgage payment.
4. Savings Accounts
Having a savings account is great for short-term emergencies. The keyword here is short-term, as this is the emergency fund to tap into should any emergency arise, such as but not limited to, a loss of a job, a medical emergency, or a need to make a large one-time payment like taxes. Short-term means within one year, anything that is longer than one year it should not be in a savings account.
The drawback of having a savings account as a long-term strategy is that the interest rate that banks pay you is low or non-existent. Factoring in the inflation, with an average inflation rate between 2-3%, the true actual purchasing power of the savings account drops because of inflation. See chart.
Although during inflationary times, interest rates rise, banks will still not provide a high-interest rate. Yet even with the interest rate the banks offer, inflation may be higher than the interest rate.
5. Investments
During an inflationary and rising interest rate environment, investments do not perform well because the implemented monetary policy slows down the economy to control inflation. Therefore, it may be an excellent time to harvest some losses during this type of environment. This strategy is called Tax-Loss Harvesting; you are allowed up to $3,000 in capital losses. We wrote another article that references this, see Capital Losses & Beware of Wash Sales.
We tell clients to keep a long-term investment diversified strategy and not focus on the short-term negativity. If you focus on the negativity, you will make emotional decisions that may push you to make a wrong decision. Remember, when the market falls, investments are at a discount.
If you manage your portfolio and like doing your research because you have time, keep these in mind. But if you feel that a professional should manage your investment based on varying strategies, consider a financial advisor with investment management services. If you want to maintain your portfolio management and want a second set of eyes, you can have a financial advisor do a financial analysis in a financial plan. A financial advisor may be flexible in meeting your needs with Project-Based Financial Planning, also known as hourly financial planning.
Your Takeaways
Inflation is the ghost that goes unknown until it drastically shocks your spending habit. When your paycheck does not move with the cost of living, it makes it even more challenging to comprehend how to keep up.
During times of low-interest environments, consumers spend by becoming more in debt. It is great buying things when free money is available, but once the free money begins to contract and interest rates start to rise, it becomes problematic. Remember, debt is not an asset to you. It is a liability; therefore, it does not generate income but rather an expense, nor does it appreciate.
Some of the things mentioned may help relieve some of the stress that is now incurring because of inflation. These last few months are a learning experience for you because inflation as a topic has become a nuisance but also a way for you to become defensive. You are now much more observant of externalities affecting your money.
Managing your spending or investing is excellent when you do it independently, as it creates a learning experience. But sometimes, having someone in your corner to help you along the way or have a second opinion may be necessary to see if you are on track. Perhaps it is time to work with a professional such as a financial advisor may be beneficial to you, especially if these are stressful times because of inflation.
Ready to take control of your financial future? Schedule your free financial assessment and discover how working with a wealth management advisor is accessible and helpful in reaching your financial goals. Start building the future and wealth you deserve.
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