How Does High Inflation Impact Your Finances?
Inflation dominated news headlines last year, as we saw the 2021 rate surge to 7%, and has carried over as a commanding topic into 2022. You surely have felt the effects, as prices have gone up for groceries, rent, used cars and even dental supplies. So, what does this mean for your financial picture and should you be concerned?
What is inflation?
Inflation is measured by a benchmark, often the Consumer Price Index (CPI), which tracks the change in prices of a group of goods and services over a period of time, such as housing, food, medical care and transportation. Inflation occurs when the cost of goods and services escalates, most often because the demand rises faster than companies can make and provide them. When the availability of those goods and services drops, they are considered more valuable and prices go up. If wages do not increase to match the higher cost of living, individuals are not able to buy as much, which can harm the economy.
We have seen this occur during 2021, for several reasons, including the Federal Reserve providing pandemic-related aid and stimulus checks, severe supply chain issues and a surge in household spending. The Federal Reserve works to control inflation by setting interest rates. When inflation gets too high, the Federal Reserve may raise interest rates, which makes it more expensive to borrow money, to slow down the economy.
What should I do about it?
Invest Extra Cash
During periods of high inflation, cash becomes less valuable, since the future value of a dollar decreases as costs rise. Keep enough cash on hand for your emergency fund (typically 3-6 months of living expenses), any short-term financial goals (1-3 years) and invest the rest.
Monitor Interest Rates
The Federal Reserve has kept interest rates extremely low during the pandemic to help stimulate the economy; however, they expect interest rates to rise by three-quarters of a percent or more in 2022. Review your interest rates on your mortgage and student loans to see if it may be beneficial to refinance, if you haven’t done so already. If you’re considering a loan for dental equipment, renovations, etc., you may want to lock in a low interest rate now.
Review Your Investment Portfolio and Strategy
When it comes to your investments, fixed income, including bonds, cash and CDs, are most affected by periods of high inflation. When interest rates rise, bond prices decline due to the fact that new bonds will be issued offering higher interest payments. If you have bonds in your investment portfolio, make sure you aren’t invested too conservatively for your time horizon, and consider short- to intermediate-term bonds instead of long-term, which are more sensitive to interest rate changes. Stocks, on the other hand, tend to far outpace inflation over the long-term, although they may face short-term volatility with changes in the economy.
Avoid the Noise and Stay Invested
If you have a well-diversified portfolio that matches your goals and timeline, stick to the course. Inflation fears have and will continue to cause volatility in the stock market; however, when investing for the long-term, current market swings and media scare tactics should not be a huge concern. History has shown that trying to outperform the market most often proves unsuccessful, and investors benefit from sticking to a low-cost, passive investment strategy. Active management funds that prioritize achieving higher returns often underperform, leaving the investor with higher fees and additional risk.
We do not know how long this duration of inflation will last, but that should not keep us from investing. If you have doubts about your investment strategy or are concerned about your financial future, now is a great time to connect with a trusted financial planner to ensure you are on track to achieve your goals and dreams.
Published in the NCDS Gazette Winter 2022 edition.