The boogeyman has historically been a mythical creature created to scare children into good behavior (the stick to Santa Clause’s carrot). I hope to introduce you to another boogeyman today, but one that is very, very real. The goal is to scare YOU into good behavior because otherwise this boogeyman will get you.
It seems that regardless of where you find your news, you haven’t been able to escape cautionary tales of inflation. Well, inflation is here and it may not go away for a while. The question is what does that mean for you and what can you do financially to harden yourself against inflation (or at least head it off a bit). First let’s examine what inflation is.
What is Inflation?
Inflation is very simply the rate at which a unit of currency loses it’s buying power (we’ll use the dollar from here on out). That means of if a candy bar costs $0.99 today and inflation is expected to be 2% over the next year, that candy bar will cost $1.01 next year. Your dollar can buy the candy today, but won’t next year and that is what economists mean when they say “your dollar has lost buying power”.
The more inflation occurring, the more buying power you are losing. The boogeyman is picking your pocket.
How Do I Avoid Inflation?
Simply put, you must outrun inflation if you want to avoid losing buying power. In 2021, the US economy saw inflation of roughly 7% which means you had to earn a 7% return on your investments to just maintain the true value of your portfolio.
Investing is the key to outpacing inflation. Many people are nervous to invest because of the risk that they will lose money, but they don’t often consider that they are almost certainly going to lose money by not investing!
There are also some specific investments that are tied to inflation called Inflation Protected Securities. Some are even backs by the government and are called Treasury Inflation Protected Securities (TIPS). Additionally, the government has recently issued Series I Bonds which are government bonds that have returns directly tied to inflation. They won’t generate a return beyond inflation, but they do make sure you aren’t losing money due to inflation.
Ask your advisor if any of the options above are pertinent to and appropriate for your situation.
Inflation doesn’t just show up in your portfolio, it also shows up in areas such as your paycheck and your living expenses. Your paycheck will seem to get spent faster and large expenses such as rent may have big increases.
Keep this in mind when discussing pay increases with employers. If the cost of living goes up 7% as it did in 2021 and you only get a 2.5% pay adjustment, you essentially just received a 4.5% pay cut disguised as a small pay increase.
Overall, inflation is death by a thousand cuts if you aren’t aware of it but by taking certain actions, you can get ahead of the boogeyman and prevent some of the damage it can cause.