It took nearly three decades, but it seems that inflation is finally here.
The prices of most items are rising significantly faster than before: In April, the consumer price index rose 4.2% yoy, more than double the US Federal Reserve’s long-term inflation target.
Inflation is not yet to be feared … at this point in time. However, you can be forgiven if you were scared of the talking heads on TV screaming that the dollar is doomed. After all, nobody wants to pay for bread in wheelbarrows with worthless dollars.
However, these inflation fearmakers have persistently overestimated risk for years, and the United States is extremely unlikely to ever hit bread / wheelbarrow inflation.
In fact, we’ve had the opposite problem for the past decade: too little Inflation. Since 2010, the consumer price index (CPI) has lagged behind the Fed’s inflation target of 2%. While this may sound good at first (who doesn’t want lower prices?), Deflation is an even more frightening problem.
(The risk is a deflationary spiral: when prices go down, consumers are reluctant to buy things because they think prices keep going down and they will get a better deal later, poorer and unable to buy goods, and prices keep going down For these reasons, the Fed is aiming to keep long-term inflation at 2% and why moderate inflation is good!)
Either way, inflation is just around the corner and consumers and investors should consider it in their financial affairs.
Here at Millennial Money, we believe that you should run your financial affairs like a prudent business owner, paying close attention to your balance sheet (what you owe or what you own) and monthly cash flow. These are always critical, but all the more so during an inflationary economy.
Here are five steps you can take to make inflation work for you.
1. Check your credit card interest rate
If you are a homeowner, unexpected inflation is positive in that it helps move assets from lenders to borrowers.
Conceptually, this phenomenon is easier to understand when you understand that your debts were spent in previous dollars (time of transaction) and you are repaying them in today’s dollars. Because of this, inflation – and the associated wage increases – benefit borrowers.
But inflation is not good for all borrowers. In fact, inflation is negative for borrowers of floating rate debt. This is because inflation is quickly built into the interest rate and the variable (higher) interest rate is then paid by the borrower. Interest rates are likely to rise as inflation hits, and consumers should consider fixing all debts now at fixed rates.
If you think you have no adjustable rate debt, think again. Although they seem to be fixed, many credit cards have a variable rate structure. The reason they are assumed to be fixed is because the indices on which interest rates are based have remained low.
Therefore, pay close attention to any change in terms and conditions for your credit card company. However, it is important to remember the best way to convert floating rate to fixed rate: pay them off in full, because a zero balance equals a zero rate.
And even if you have fixed rate credit cards, you won’t be over the moon as many credit card companies have sneaked in on loan terms that allow them to change the way interest rates are calculated and calculated at their own discretion, only to give you the option give to decide by closing the account.
2. Take care of your big ticket stuff
Most failing businesses have one thing in common: deferred maintenance. It is the cumulative effect of years of delays in service and underinvestment in the assets of their balance sheet. In many cases, the life of critical equipment, buildings and machinery could have been significantly extended if normal and routine maintenance had been carried out. (To quote your mother, “An ounce of prevention is worth a pound of cure.”)
It’s not just companies, however. On a personal level, it doesn’t take a financial genius to notice that salespeople nowadays have the upper hand in negotiating houses, cars, or even repair services. Extending the functional life of your large assets and making larger purchases on your own terms is a win-win situation.
Even small updates help. According to the state website Fuel Economy, you can improve your gas mileage by up to 3% by keeping your tires properly inflated while reducing tire wear. While this will certainly not counteract the effects of significant inflation, it does help cushion gas price increases with very little effort on your part.
3. Reconsider Your “Elevation”
Have you got a raise lately? It may not help you as much as you think.
Many employers used to offer two increases a year: one based on cost of living (hello, inflation) and one based on individual and company performance. Lately, many companies only give a single, sweeping raise per year. For years the usual 3% increase was sufficient to cover inflation while providing a small performance-based increase.
But … the CPI rose 4.2% yoy in April.
So if your raise is less than the general rate of inflation (as in the 3% example above), your standard of living will go down In spite of get a higher paycheck.
It looks like this is the case with many companies that went into cash-on-hold mode last year and haven’t made any significant hikes this year while inflation is rampant.
At the same time, many companies pay high sums for new employees. The opportunity here for many workers is pretty simple: use this newfound strength to see if your skills and selling price are now worth more to new employers.
Remember, you are selling your labor, so this shouldn’t be any different from companies like Procter and Gamble, which recently raised the cost of their products due to higher inflation. In this environment it is worthwhile to explore and test the market for your talents.
4. Protect your investment portfolio
Do you remember how above-average inflation transfers assets from lenders to borrowers?
Well, if you have fixed income investments like bonds, you take on the role of the lender. Any spike in inflation and the Fed’s response (possibly interest rate hikes on new debt) will result in lower prices for existing debt in your investment portfolio.
So what can you do to add fixed income investments to your portfolio and still make some cash?
Historically, the best asset classes for an inflationary environment – in addition to stocks – treasury inflation-protected securities (TIPS), real estate and real estate investment trusts (REITs) as well as precious metals such as gold. In theory, fixed total circulation cryptocurrencies like Bitcoin should be able to act as inflation protection, but have different risk factors that make them more volatile than traditional investments.
Beware of stocks: A stock is nothing more than ownership of an underlying company. Not all companies are able to pass inflation on to their customers, for example if they operate in a highly competitive industry or are not market leaders. Previously, we wrote about three investments we liked because of inflation with a popular company that has been raising its prices for more than a decade.
5. Establish a post-pandemic budget
Many Americans were surprised to find they had extra cash during the pandemic. In addition to a few rounds of stimulus checks, there was what Goldman Sachs called “forced saving,” essentially the money Americans saved by not being able to go to the movies, vacation, or even work Had to commute (and spend $ 8 on crappy sandwiches for lunch across from the office). Even when Americans were spending money, it was often about lower-cost activities like local camping.
At the same time, Americans were spending more on stay-at-home services like streaming video and the pesky but potentially rewarding Instacart delivery fees.
Perhaps there is a way to divide up the difference in this post-pandemic world: set a new budget that takes into account some of the savings lessons from last year, and cancel some of your streaming services (the subscription costs of which are likely to be soon) climb).
Some more examples of a “Best of Both World” approach:
- Pack your lunch when you return to the office
- Swap an expensive vacation for a return to a campsite (especially this summer when travel prices are affected by significant demand)
Reducing your pandemic-era services with the economy reopening should help keep your personal bottom line in order.
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