As we’ve all noticed, inflation has been on the rise lately – the consumer price index fell from 1.6% at the end of the first quarter of 2021 to around 3.4% for the second quarter. And that has major implications for how you should manage your money: your savings, your investments, and your retirement planning.
âInflation can have devastating effects on the economy, on your retirement plans and on your personal finances,â said Terry Savage, my co-host of the âFriends Talk Moneyâ podcast, in our new episode on The inflation (you can hear it everywhere you listen to podcasts). .)
But let’s not get carried away. We are not talking about an inflation rate close to the 15% rate of the late 1970s and early 1980s and no one expects a return to those bad old days. Yet, as Savage, my other podcast co-host Pam Krueger and I explained, rising prices are now a definite economic trend and should be factored into your personal financial planning.
Here are eight points from the âFriends Talk Moneyâ episode to help you and your money cope with inflation:
1. Keep inflation news in context. Yes, inflation is on the rise. And government borrowing inflates the federal deficit, which is an inflationary concern. But, in many cases, the percentage increases in inflation come from a low baseline – a year ago, when the pandemic artificially lowered the cost of things like hotels, airline tickets. and wood.
As the Wall Street Journal noted: âAirfares rose 24% in May from the previous year, but are down 6% from their pre-pandemic level. “
So be careful with the inflation numbers when comparing the percentage increases with the prices in May or June 2020.
Also, as I noted on the podcast, some prices are going up due to the âLife is Too Shortâ effect. Lifting pandemic restrictions and COVID-19 vaccinations have led millions of Americans to suddenly book flights, hotel rooms, rental cars and restaurants, feeling they don’t want to miss the opportunity now .
I read that the price of a car rental in Bozeman, Mont. increased 278% from last year, to $ 259 per day!
See: What is inflation? Hint: This is not the 12% increase in rental car prices last month
At some point, the spending madness will dissipate and the prices will reflect that. I can speak from personal experience: One of my sons was hoping to fly from California to visit my wife and I in New Jersey, but the cost of the plane ticket made him change his mind.
Likewise, we will see a slowdown in price increases due to pandemic shortages. This has happened with lumber before and will likely be seen with cars and computers, the costs of which have increased due to the shortage of semiconductor chips resulting from shipping restrictions.
Also note: the spike in inflation in the early 1980s was partly due to rising wages, at a time when unions were strong and could get employers to raise wages along with inflation. . Today, unions are weaker and have less leverage to raise workers’ wages, which then serves as a moderating force against inflation.
Federal Reserve Chairman Jerome Powell believes that much of the inflation we see will be “transient” and it is difficult to argue with him.
2. Stress test against inflation in your plans. âShould we be worried about inflation? Well, maybe the answer is, âDon’t worry, try to plan,â Krueger said.
By that, she meant planning what-if scenarios as you project your finances into the future, with assumptions about what an annual inflation of 3%, 4%, or 5% might mean for your personal expenses, your income, your money. savings and your investments.
âPersonally plan for higher prices and maybe the possibility of higher interest rates to follow,â Krueger advised. âFinancial planning and retirement planning are nothing more than assumptions. Take your educated guesses and turn those assumptions into projections for the future. Test your retirement plans using different assumptions about inflation and higher rates.
3. Figure on higher Social Security benefits over the next year or two. Social Security benefits have annual cost of living adjustments (COLA) indexed to inflation. Last year, the COLA barely fizzed, at 1.3%. But Savage said: âFor the year 2021, they say it could be at least 5%. We’ll see.”
An increase in social security benefits could be good news for people in their 60s, 70s and 80s living on a fixed income.
4. Look for opportunities in the coming months to earn higher returns on your savings. Rising inflation tends to push up interest rates, which could be good news for savers.
But the ripple effect has yet to materialize for money market accounts or bank CDs. The average rate for a five-year CD is still a paltry 0.3% and for a one-year CD it is only 0.17%.
As Krueger said, âBanks are very quick to raise mortgage and borrower rates and very slow to pull the trigger to raise rates for savers. “
Savage’s advice for now: âDon’t lock in your savings for more than six months now, because interest rates may go up. Then you can transfer some savings to a higher rate CD.
5. Lock in low fixed rates on mortgages and other loans while you can. These rates have increased and are expected to continue to rise. So, if you are planning to get a mortgage or a fixed rate car loan, you might want to do so before they get more expensive.
Conversely, now is the time to avoid adjustable rate loans, as they are almost certainly forced to raise their rates for borrowers in the coming months.
See: As mortgage rates exceed 3% for first time since April, economists warn they will likely rise
6. Avoid long term bonds. Generally speaking, the longer the term of a bond, the more its price will fall when interest rates rise.
“If you lock in a 30-year bond at the current low interest rates of 2-2.5%, and we have inflation, that bond issuer might sell bonds at a rate of 4% or 5. %, âSavage said. âSo it’s going to be really stupid to be locked up for 30 years. Inflation is going to devastate the price of the bond.
7. Continue to invest in stocks for the long term. While stocks don’t offer guaranteed returns, Savage noted that in every 20-year period since 1926, a diversified basket of stocks with reinvested dividends has consistently earned investors more than the rate of inflation.
8. Keep an eye on what the Federal Reserve is doing to manage inflation. Savage compared what the Fed does to a hot tub, its water representing the US economy. Before you take one, you want the water to be the right temperature and not overflow.
“If someone walks up and turns on the switch, causing the water to swirl, you’d bet it would overflow.” And that’s the speed, âSavage said. Then, using this metaphor of economics, she added, âIt’s the money that moves fast. [causing inflation]. And we haven’t had that yet. And our Fed Chairman Jay Powell is absolutely determined that we don’t have that kind of inflation, but we don’t get lost either. “
Lily: Used car prices soar and sticker shock is likely to worsen
However, Powell also said that “if we saw any signs that the inflation path or long-term inflation expectations were moving significantly and persistently beyond levels consistent with our target, we would be ready. to adjust the stance of monetary policy “.
Translation: The Fed has worked to keep inflation at around 2%, keeping interest rates low, and plans to keep that target as its target. To do this, the Fed expects to raise interest rates over the next few years.
Richard Eisenberg is senior web editor for Next Avenue’s Money & Security and Work & Purpose channels and editor of the site. He is the author of “How to Avoid a Mid-Life Financial Crisis” and has served as the personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch.
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