Key Takeaways:

1. Inflation diminishes purchasing power, making it hard to stretch your dollars as far
2. Implementing good financial habits early allows for adaptability if inflation strikes
3. Avoid being caught off guard by proactively accounting for inflation in your financial plan

Simply put, inflation measures the average price change in a category or basket of goods and services. Inflation is always present, but during times of higher inflation, your purchasing power is diminished faster, and paychecks don’t go as far as they once did. Feelings of worry during these phases are valid.

With inflation’s rising impact on day-to-day finances, it’s worth revisiting how it should be factored into budgeting, goal setting, and building your financial plan in order to ease worry and proactively stay ahead of potential adverse consequences.

The Good & Bad of Inflation

Inflation the Bad: No one enjoys having to make their money work harder and do less. Inflation’s downside is that while it’s similar to compounding (see the power of saving), this powerful force is actually working against you and your goals, eroding your wealth over time.

Inflation the Good: While inflation is negative on a microeconomic level, from a macroeconomic standpoint, it encourages consumers to spend now and purchase goods in the moment. Strong consumer spending increases the velocity of money across the entire economy, boosting revenues, incentivizing investment, and helping act as a lubricant for labor costs.

The Rule of 72 is a simple calculation to estimate the number of years it takes to double your money based on an annual rate of return. For example, your money would double in 7.2 years if your investment grew at 10%. This formula can also be used with inflation, however instead of doubling your money, it calculates the numbers of years until the starting value will be cut in half. Per this formula, using a 3% inflation rate, one dollar will be worth half as much in 24 years (i.e., 72 / 3% = 24 years).

That deterioration is problematic when planning for retirement as money simply doesn’t cover what you thought it would. If there was ever another reason needed for a sound financial plan, this is the situation. For example, retirees on fixed incomes that don’t track inflation can experience a steep decrease in spending power as that same income does not carry the value it once did.

What Can You Do?

Some small, stable amount of inflation is a necessary reality of a healthy, growing economy. But when inflation is a bit higher than normal, the main thing to remember is to keep saving and investing by setting goals and managing expenses accordingly. And because of the diminished spending power that comes with inflation, it may also mean making minor adjustments to your cash flows to maintain healthy finances, such as paying down debt ahead of time.

The following are five areas to assess and adjust to help you stay on track to meet your goals.

1. Cash: Avoid staying in cash. Best practice is to have either less than 5% of your portfolio or 12 months’ worth of expenses in cash and invest the rest. If you are hesitant to buy into the market, consider dollar-cost averaging as a strategic way to start.
2. Equities: Over the long-term, equities are usually the best hedge against inflation. Businesses can adjust up prices to offset inflation and rising expenses; therefore, business ownership through equities can protect against inflation. Work with an active portfolio manager to navigate times of volatility and changing economic environments with expertise and confidence.
3. Debt: For debt, such as credit card balances, continue paying and exceed minimum payments when possible. Keeping this mentality with healthy financial habits puts you on track to financial wellness.
4. Retirement contributions: If you are working, continue to make contributions to your retirement accounts (e.g., 401(k), SEP IRA, and Simple IRA). For those who must lower their contributions to account for higher food and energy prices, continue contributing an amount that is at least equal to your plan’s employer match until inflation pressures and rising prices subside. This way you have flexibility with your paycheck but aren’t completely neglecting your retirement, as well as still capitalizing on the benefits.
5. Proactive planning: A proper financial plan accounts for the impact of inflation and factors in inflation-adjusted returns to determine the real growth of your savings. Our advisors use a conservative inflation factor when planning, above what has been seen in recent history. This helps accurately and proactively plan against changing economic conditions.

These five steps are guidance on how to stick to your plan, regardless of what inflation does, and helping you avoid making short-term mistakes that affect your long-term goals. If at any time you want to review your plan with a Financial Consultant, reach out and our team is happy to schedule a call.

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The information in this paper is not intended as legal or tax advice. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.