7 tips to combat inflation with your personal finances

There has been a lot of discussion about inflation as we have seen the economy pick up in 2021. Traditionally, fiscal and monetary actions by the government (things like big spending and low interest rates) would lead to higher inflation. So it was no surprise that year-on-year inflation came in at 5.4% in July, more than double the normal for the past two decades.

The real question is, will this be a lasting trend and what are its retirement risks? Economists are getting to both sides of the argument.

For almost 40 years, inflation has been tame. However, meek does not mean toothless. Here’s what I mean: If I had buried a million dollars in a briefcase when I graduated from West Point in 1988, rising prices or inflation would have eroded about 60% of my purchasing power in the years that followed. No, if you’re wondering, I didn’t have a briefcase or a million dollars, but let me get back to business. That kind of erosion occurred during a period of relatively light inflation.

Here are some key considerations as you look to hedge your own finances against inflation:

  1. Understand your personal inflation rate against the CPI. Inflation is generally measured by what is known as the consumer price index, or CPI. The CPI measures the average change over time in the prices that we, as consumers, pay for goods and services. Although the calculation is complex, keep in mind that it represents a weighted average of expenses. This is different from your personal inflation rate because your lifestyle, spending and saving habits are unique. As a starting point for your inflation-proofing efforts, consider using an online calculator to determine your personal inflation rate.
  2. Build inflation-friendly investments into your portfolio. Consider the following options:
    • Stocks. Beating inflation has long been a reason to invest in stocks of all kinds. The history speaks for itself. Big US stocks have outperformed inflation over the last 100 years by about 7% a year. Dig a little deeper and you may want to check out stocks that perform well in an inflationary environment. Food, health care, energy and building materials stocks have generally done well. Of course, broad-based indices probably make this approach easier, less expensive, and more manageable.
    • Inflation Protected Treasury Securities. TIPS are issued by the US government and are designed to keep pace with inflation. In practice, the price of these bonds increases with inflation, so they do not lose purchasing power. Although the fixed interest rate remains the same during the life of the bond, the value to which it is applied would increase in an inflationary environment. They can be purchased directly through the US Treasury Department at treasurydirect.gov. At maturity, the principal amount of the bond is guaranteed by the United States government. Inflation adjustments to the principal amount of the bond are taxable income, so keeping it in a retirement account would allow you to avoid “phantom income.”
    • Bonds I. Series I Savings Bonds are not your grandmother’s savings bonds. They come with a yield based on a combination of a fixed rate that remains the same over the 30-year life of the bond and an inflation rate that resets twice a year. Unfortunately, there is a maximum purchase of $10,000 per year, but they can be a solid solution to address inflation within your portfolio.
    • Commodities and real estate investments. As prices rise, it would make sense that you could see an increase in the prices of all kinds of commodities, precious metals, and, yes, real estate. Own a rental with a fixed-rate loan, and the principal and interest component of your rental expenses are locked in. As a bonus, rental income can be inflated.
  3. Plan for higher interest rates. Historically, higher interest rates come with higher inflation. Remember those double-digit interest rate CDs in the 1980s? Consider securing historically low mortgage rates by refinancing, and focus on removing variable-rate debt, like credit cards, from your balance sheet before rates skyrocket.
  4. Examine and review your mortgage. If you’ve already taken advantage of low interest rates, you may be tempted to stick with your mortgage, particularly since the principal and interest portion of the payment won’t increase. However, a mortgage is probably your biggest expense, and less is more when it comes to cash flow commitments.
  5. Monitor short-term cash equivalents. It doesn’t seem that long ago that the disparity between money market funds and traditional savings accounts was huge. That could happen again if inflation persists and rates rise. Keep an eye on what’s going on so you don’t get caught with cash equivalents that aren’t working as hard as they could.
  6. Watch out for the ups and downs of bonuses. The fact that bond values ​​decline as interest rates rise could make long-term fixed-rate bond investments particularly vulnerable, unless you plan to hold the bonds to maturity. On the other hand, floating or adjustable rate fixed income investments may perform relatively better.
  7. stay ahead. This may not be a welcome message, but it should be a consideration. Salary levels are influenced by inflation. As long as your income rises with inflation, continuing to work can help you beat rising prices.

I don’t have a crystal ball, but I do believe that we all need to have a flexible game plan, and that includes fine-tuning the tools to combat inflation.

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