A small, steady amount of inflation is considered good for the economy. But when prices rise faster than wages, the value of your money goes down. This can have a negative impact on quality of life, especially for those with middle and lower incomes. It can also complicate saving for emergencies and investing for retirement. Fortunately, there are steps you can take to fight the effect of rising prices on your household finances. Read on to learn what inflation is and how to stay ahead of it.
Key Points
• Inflation refers to a general rise in the price of goods and services over time.
• Inflation erodes your money’s purchasing power, meaning you can buy less with your money than you could previously.
• High-yield savings accounts and diversified investments, including TIPS and I-Bonds, can help protect your finances against inflation.
• Cutting back on nonessential spending, lowering monthly bills, and paying down high-interest debt are other ways to fight inflation.
• Career moves such as negotiating a raise, changing jobs, or starting a side hustle can offset inflation’s impact on your income.
• As a response to inflation, the Federal Reserve generally raises interest rates to slow borrowing and spending and cool the economy.
Understanding Inflation
Here are key things to know about your money’s purchasing power and how it changes over time.
Inflation Definition and Causes
Inflation refers to the rising cost of goods and services over time. If the price of one or two items spike, however, that’s not inflation True inflation occurs when costs generally increase across the board, making the things consumers normally spend money on more expensive. Some inflation is the sign of a healthy economy. In fact, the Federal Reserve (a.k.a., “the Fed”) likes to see an annual inflation rate of around 2%. But sometimes inflation runs much higher, as it did in the years following the Covid-19 pandemic, which can lead to financial strain.
While inflation has multiple causes, it often stems from a mismatch between demand for goods and services and the supply of those goods and services. Events that raise production costs or disrupt the production of goods in the economy (such as a pandemic, war, or natural disaster), can also lead to an increase in prices. Inflation can also be influenced by monetary policies, such as the Fed deciding to adjust benchmark interest rates or print more money.
How Inflation Affects Your Purchasing Power
When the cost of things you normally buy goes up, your purchasing power (the amount you can get in return for every dollar you spend) goes down. In other words, your money doesn’t stretch as far as it used to.
At the same time, investments and savings accounts that don’t offer returns above the inflation rate may actually lose value in real terms. For instance, if you put $500 in a savings account paying an annual percentage yield (APY) of 0.01%, you’ll have $500.05 at the end of a year. Even at the Fed’s target 2% inflation rate, $500.05 will buy you less than $500 did a year ago, so your purchasing power has declined. Fortunately, many online savings accounts offer APYs that beat inflation, so your money grows rather than shrinks over time.
Strategies for Protecting Your Money
Inflation is a fact of life — even when inflation is low, prices tend to creep over time. So how can we fight inflation? Here are a few strategies to consider.
Earn More on Your Savings
Savings accounts offer liquidity (meaning you can easily access your funds when you need them), making them a good place to stash any cash you may need in the next few months or years. On the downside, traditional savings accounts typically don’t keep up inflation. To ensure your funds don’t lose value over time, you’ll want to look for a savings account with APY that’s close to or beats the current rate of inflation, such as a high-yield savings account.
Other Options to Consider to Outpace Inflation
Having a diversified portfolio (including stocks, bonds, and short-term investments) can help protect you from periods of hyperinflation. Some options to consider:
• I-Bonds: Series I Savings Bonds are U.S. government-backed securities that adjust their interest rate with inflation. They offer a fixed rate plus an inflation-adjusted rate, making them a low-risk way to protect your money’s value over time. Just keep in mind that this isn’t a short-term saving strategy — you need to leave your money deposited in the bond for at least five years to avoid forfeiting some interest.
• Real estate: This area can be another strong inflation hedge, as property values and rental income tend to increase with inflation (though this will depend on local market conditions). Investing in real estate investment trusts (REITs) can offer exposure to real estate without the need to own physical properties.
• Inflation-protected securities: With Treasury Inflation-Protected Securities (TIPS), the principal, called the par value, goes up with inflation, providing some stability in times of rising prices. When a TIPS matures, you get either the increased (inflation-adjusted) price or the original principal, whichever is greater. These can be a safer investment compared to traditional bonds, which may lose value when inflation rises.
Adjusting Your Budget and Spending Habits
To make up for the higher costs of goods and services, you may want to check in on your budget and look for places where you can cut back on spending. It’s generally easiest to do this with nonessential expenses, like dining out and entertaining. But you may also be able to find ways to trim the cost of essentials. Some ideas:
• Shop for generics at the grocery store and use coupons whenever possible.
• Make adjustments to your energy consumption to lower your utility bills.
• If you rent, ask your landlord if you can trade services — such as cutting the grass or shoveling the sidewalk during the winter — for a rate reduction.
• Reduce your driving and use an app to find the cheapest gas prices near you.
• Buy non-perishable items in bulk — this allows you to lock in current prices before they rise further.
Recommended: Is Inflation Good or Bad?
Career Moves to Combat Inflation
Increasing your income can help offset inflation’s impact on your finances. While this may be easier said than done, you might have more options than you think. Here are some career moves to consider during inflationary times:
• Negotiate for a raise: If it’s been a while since your last raise, now may be a good time to ask for one, citing either the high inflation rate or the added value you bring to the company — or both.
• Find a new job: In some cases, changing jobs may provide a quicker path to a higher salary than waiting for a raise.
• Invest in skill development: Acquiring new skills or certifications can make you more valuable to employers, increasing your potential for higher wages.
• Explore side hustles: Freelancing, consulting, or starting a small business on the side can provide additional income streams to help combat rising costs.
Government Programs and Policies
The government can (and typically does) take a number of actions to combat inflation and help American consumers deal with rising costs. Here are some of the tools they have in their arsenal:
• Raising the federal funds rate: One of the most common ways the Fed will fight inflation is by raising the federal funds rate, which is a benchmark interest rate that influences other interest rates. Raising the federal funds rate generally makes borrowing for businesses and consumers more expensive. This slows down spending, which can cool off the economy and lower inflation.
• Tax adjustments: The government may also adjust tax brackets and standard deductions to prevent “bracket creep,” where inflation pushes taxpayers into higher tax brackets.
• Stimulus programs: In times of economic difficulty, stimulus checks or other government support measures may be provided to help individuals manage higher living costs.
Recommended: How the Federal Reserve Rate Impacts Your Savings
Smart Borrowing in Inflationary Times
As mentioned above, the Fed will often raise interest rates during times of high inflation. While this can help tamp down rising prices, it also makes borrowing money more expensive.
For many people, the biggest impact of these rate increases is on credit cards, which have a variable interest rate. When rates are high, you want to be careful not to carry a balance from month to month. If you already have credit card debt, it’s a good idea to focus on paying it down.
If you’re in the market for a new mortgage during a time of high inflation, you might benefit by choosing a variable rate loan. That way, if rates begin to fall, your mortgage’s rate will likely also go down. On the other hand, if inflation (and rates) appear to be on the rise, you may be better off with a fixed-rate mortgage to lock in current rates.
Long-Term Planning for Inflation
When saving and investing for future goals, such as retirement, it’s important to factor in inflation. Rising prices can affect your long-term financial plan in two main ways:
• The real return on your investments: You’ll need to consider not just the interest rate you expect to receive but also the real rate of return, which is determined by figuring in the effects of inflation. Your financial advisor can help you calculate your expected real rate of return on your investments.
• Future costs: When calculating how much money you’ll need to comfortably retire, it’s important to estimate future living expenses with inflation in mind. This may mean adjusting your target retirement savings to account for an increased cost of living. There are online calculators that can help you model out what inflation-adjusted numbers would look like.
The Takeaway
Inflation is an inevitable part of economic life. Ideally, the Fed tries to limit the inflation rate to 2% annually, but sometimes a shift in supply and demand and other factors can lead to a spike in the inflation rate.
Government programs and policies can offer support when inflation gets too high. There are also steps you can take on your own to make your finances more inflation-resistant. These include spending less, boosting your annual income, avoiding high-interest debt, and choosing investments and savings accounts that protect the value of your cash so it grows (rather than shrinks) over time.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
What types of investments typically perform well during inflation?
During inflation, certain investments tend to perform better because they can keep pace with or outgrow rising prices. Stocks, especially in sectors like consumer goods and energy, may see gains as companies pass higher costs onto customers. Real estate often appreciates, and rental income may rise with inflation. Lower-risk investment options include: Treasury Inflation-Protected Securities (TIPS), which adjust with inflation and help safeguard your purchasing power, and I Bonds, which have a variable interest rate that adjusts for inflation.
How can I adjust my budget to cope with inflation?
To cope with inflation, it’s a good idea to review your budget and identify areas where you may be able to cut back on spending, such as dining out, entertainment, and gym memberships. This can free up funds to cover the rising cost of essential monthly expenses, like groceries, rent, utilities, and gas. Other smart moves to beat inflation include: paying down debt (especially high-interest credit cards), boosting your income, and adjusting your emergency savings fund to account for a higher cost of living.
Does increasing my savings rate help combat inflation?
Yes, increasing your savings rate can help combat inflation. If you put your money in a savings account that pays more than the current rate of inflation, it will offset the loss of purchasing power and ensure your savings grow despite inflationary pressures. Increasing your savings also helps you build a larger financial cushion to cover rising costs.
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