Steps to Take Now to Guard Against Inflation

Well, it’s official. Inflation is here, and it is here big. According to reports, inflation is now surging at its fastest pace in 30 years. If you were born after 1960, you’ve never really experienced a bout of severe inflation because it hasn’t been an issue for the last three decades. However, as shocking as rising food and gas prices are, we have been through this before. People managed to survive the inflationary storm of the late 70s and early 80s, and we’ll get through this. Understanding how to guard against inflation is key to coming out on top after it’s all over.

The Effect of Inflation on Your Finances

When most people think about inflation, it’s about higher food and gas prices. That’s certainly a big part of it because you can feel it in real-time in your pocketbook. However, there’s much more to inflation and the way it affects your everyday lives. Understanding inflation’s broader impact is key to making the right decisions regarding your personal finances.

Erodes Purchasing Power

Over the longer term, an inflationary environment can decrease your purchasing power. Simply stated, a dollar today is worth less in the future. This can be especially problematic for people near or in retirement. Even at three percent inflation, you can lose half your purchasing power over a 23-year period. Higher inflation, such as we experienced in the 1980s, could cut it even faster. For example, a seven percent inflation rate would reduce your purchasing power by half in just over ten years.

Reduces the Value of Savings

If your savings cannot keep pace with the rate of inflation, you could lose even more purchasing power. If the inflation rate exceeds the savings interest rate, it eats away at the value of your savings. For example, the current average interest rate on savings is below 0.3 percent, but the annual CPI for 2020 was 2.3 percent. So even though you see your savings account credited with interest each year, it is actually losing two percent due to inflation.

Leads to Higher Interest Rates

Inflation can have a direct impact on interest rates. The Federal Reserve’s response to higher inflation expectations is to increase short-term rates, which increases the rate banks pay to borrow money. The banks respond by increasing consumer borrowing rates. The end result is less money to spend on goods and services.

Moves You Can Make Now to Help Stave Off Inflation

Lock in Variable Rate Debt

As interest rates rise, the cost of variable-rate debt, such as credit cards and adjustable-rate mortgages (ARMs), will increase. Now would be the time to consider freezing your debt costs by converting your variable-rate debt to fixed-rate debt. Fixed mortgage rates are still near historic lows, so the timing on that couldn’t be better. For credit card debt, consider paying it off as soon as you can or replacing it with a fixed personal loan.

Make Anticipated Large Purchases Now

It’s probably too late for a car purchase because new and used car prices have already been surging. But, prices of durable goods, such as appliances, while higher than last year, can expect to go higher. Now would be a good time to make any home improvements you’ve been considering.

Invest in Real Assets

Commodities and real estate tend to perform well in inflationary environments because they eat inflation for breakfast. The value of commodities such as oil, industrial metals, and precious metals tends to increase at least at the same rate as inflation. However, commodities tend to be more volatile than other asset classes over time, so it would be wise to keep your allocation to commodities at a minimum.

Investment in rental properties can be a good inflation hedge because landlords can increase rent payments, leading to higher cash flow. If you can’t or don’t want to become a landlord, consider investing in real estate investment trusts (REIT).

Invest in TIPS

Treasury Inflation-Protected Securities (TIPS) are issued by the U.S. government. The rate on TIPS is adjusted according to the CPI, resulting in a more stable performance than other fixed-income assets. You can also invest in TIPS through an exchange-traded fund (ETF)

Avoid Keeping too Much Money in Cash

Aside from keeping enough money in savings to cover emergency expenses for six to twelve months, you should avoid keeping too much money in cash savings. Savings accounts yield less than a half percent, which means inflation is eating away at its value.

While you can’t control when or if inflation will strike again, you can take actions that will protect your portfolio against its effects.