For richard Eisenberg, next avenue Editor
As we have all noticed, inflation has been on the rise lately: the consumer price index rose from 1.6% at the end of the first quarter of 2021 to around 3.4% for the second quarter. And that has important implications for how you should manage your money — your savings, your investments, and your retirement planning.
“Inflation can have devastating effects on the economy, on your retirement plans, and on your personal finances,” said my “Friends Talk Money” podcast co-host, Terry Savage, in our new episode on inflation (you can listen wherever you listen). the podcasts). ).
But let’s not get carried away. We are not talking about inflation approaching the 15% rate of the late 1970s and early 1980s and no one expects to see a return to those old days. Still, as Savage, my other podcast co-host Pam Krueger, and I explain, rising prices are a definite economic trend right now and should be factored into your personal financial planning.
Here are eight points from the episode “Friends Talk Money” to help you and your money keep up with inflation:
1. Keep inflation news in context. Yes, inflation is going up. And government borrowing is causing the federal deficit to skyrocket, which is an inflation concern. But, in many cases, the percentage increases in inflation come from a low benchmark: a year ago, when the pandemic artificially lowered the cost of things like hotels, airfare and lumber.
As the Wall Street Journal noted: “Air fares were up 24% in May compared to a year earlier, but down 6% from their pre-pandemic level.”
So watch out for inflation numbers comparing percentage increases to prices in May or June 2020.
Also, as I pointed out on the podcast, some prices are going up due to the “Life is too short” effect. The lifting of pandemic restrictions and COVID-19 vaccinations have prompted millions of Americans to suddenly book flights, hotel rooms, rental cars and restaurants, feeling they don’t want to miss out now.
I read that the price of renting a car in Bozeman, Mont. is up 278% from last year, at $259 a day!
At some point, the spending wave will dissipate and prices will reflect it. I can speak from personal experience: one of my sons was hoping to fly from California to visit my wife and me in New Jersey, but the cost of the airfare made him change his mind.
Similarly, we will see a slowdown in price growth due to pandemic shortages. This has already been happening with wood and will likely be seen with cars and computers, the costs of which have risen due to shortages of semiconductor chips as a result of shipping restrictions.
Also worth noting: the skyrocketing inflation of the early 1980s was due in part to rising wages, when unions were strong and could get employers to raise wages along with inflation. Today, unions are weaker and have less influence in raising workers’ wages, which then serves as a restraining force against inflation.
Federal Reserve Chairman Jerome Powell believes much of the inflation we’re seeing will be “transient,” and it’s hard to argue with him.
2. Do an inflation stress test on your plans. “Should we worry about inflation? Well, maybe the answer is, ‘Don’t worry, try to plan,'” Krueger said.
By that he meant doing what-if scenario planning as you project your finances into the future, with assumptions of what 3% or 4% or 5% annual inflation might mean for your personal spending, income, savings and investments. .
“Personally plan for higher prices and perhaps the possibility of higher interest rates to follow,” Krueger advised. “Financial planning and retirement planning is nothing more than making assumptions. Take your guesses and turn those assumptions into projections for the future. Stress test your retirement plans using different assumptions about inflation and rates more high”.
3. Figure on higher Social Security benefits in the next year or two. Social Security benefits have annual cost-of-living adjustments (COLAs) linked to inflation. Last year, the COLA barely bubbled, at 1.3%. But Savage said, “By 2021, they say it could be at least 5 percent. We’ll see.”
An increase in Social Security benefits could be good news for people in their 60s, 70s and 80s who live on fixed incomes.
4. Look for opportunities in the coming months to earn higher returns on your savings. Rising inflation tends to push up interest rates, which could be good news for savers.
But the ripple effect has not yet manifested itself in money market accounts or bank certificates of deposit. The average rate for a five-year CD is still a measly 0.3% and for a one-year CD it’s just 0.17%.
As Krueger put it: “Banks are too quick to raise rates for mortgages and borrowers and too slow to pull the trigger to raise rates for savers.”
Savage’s advice for now: “Don’t keep your savings for more than six months now because interest rates may go up.” Then you can move some savings to a higher rate CD.
5. Secure low fixed rates on mortgages and other loans while you can.Those rates have been rising and are expected to continue to rise. So if you’re thinking about getting a fixed-rate mortgage or car loan, you may want to do it before they get more expensive.
Rather, this is a time to stay away from adjustable-rate loans, because they are almost certain to raise their rates for borrowers in the coming months.
6. Avoid long-term bonds. Generally speaking, the longer a bond’s term, the more its price will fall when interest rates rise.
“If you insure a 30-year bond at today’s low interest rates of two, two and a half percent, and we have inflation, that bond issuer could be selling bonds at a rate of four or five percent,” Savage said. “So it will feel really silly to be locked up for thirty years. Inflation will devastate the price of the bond.”
7. Keep investing in stocks for the long term. While stocks don’t offer guaranteed returns, Savage noted that during every 20-year period since 1926, a diversified basket of stocks with dividends reinvested has consistently earned more for investors than the rate of inflation.
8. Keep an eye on what the Federal Reserve is doing to control inflation. Savage compared what the Fed does to a hot tub, with its water representing the US economy. Before taking one, he wants the water to be at the right temperature and not overflow.
“If someone walks up and flips the switch, causing the water to start spinning, I’d bet it would overflow. And that’s the speed,” Savage said. Then, using this economics metaphor, he added: “That’s money that moves fast. [causing inflation]. And we haven’t had that yet. And our Fed Chairman Jay Powell is absolutely determined that we won’t have that kind of inflation, but we won’t go down the drain either.”
However, Powell has also said that “should we see signs that the path of inflation or longer-term inflation expectations are moving materially and persistently beyond levels consistent with our target, we would be prepared to adjust our policy stance.” monetary policy”.
Translation: The Fed has been working to keep inflation around 2% by keeping interest rates low, and plans to maintain that target. To do this, the Fed plans to raise interest rates in the coming years.