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Managing Your Finances During Inflation

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Inflation can have a serious effect on your finances. When prices start to rise, consumers lose their purchasing power, which means your money won’t go as far as it used to. You may not be able to control inflation, but you can change the way you manage your finances during these uncertain times. Learn more about the effects of inflation and the impact it can have on your savings and income.

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Yellow notepad with pen svg icon Lesson Notes:
  • When inflation increases, consumers lose purchasing power and can’t afford as many goods and services as they could before.
  • Inflation may reduce the value of your savings over time, leaving you with less money for the future.
  • You may be able to outpace rising prices by investing in high-yield assets that will grow faster than the rate of inflation.

What are the Effects of Inflation?

Inflation refers to sustained increases in the price of various goods and services. Economists measure inflation over set periods of time by tracking the price increases for these items. Some inflation is necessary for economic growth, but too much inflation can also make common goods and services more expensive.

The country’s central banking system, the Federal Reserve, and elected officials can help control the pace of inflation. The government can print more money and encourage spending with a stimulus, which increases inflation. They can also lower interest rates which reduces the cost of borrowing money (i.e. buying a home or car with a loan), which also may increase inflation.

Businesses and consumers will be more eager to borrow money when interest rates are low. The government will usually take these steps during periods of economic recovery, which increases demand for products and services.

On the other hand, the government can also try to ease inflation by raising interest rates. This increases the price of starting a business or taking out a loan. Borrowers will need to spend more money paying down their interest, which can deter people from borrowing at all. Money inherently becomes more valuable because there is less of it moving around the market.

Not all goods and services are created equal. Economists measure inflation by tracking the Consumer Price Index (CPI), which lists the price of goods and services that consumers buy most often. The index is updated monthly and is available to the public. The CPI consists of essential goods and services, such as food, transportation, clothing, housing and utilities.

How Does Inflation Affect Your Finances?

Inflation will affect everyone differently, but most people won’t be able to buy as many products or services as they could before.

High inflation makes it more expensive to do just about everything, including putting food on the table, filling up your gas tank, or even going out with your friends. You may need to change the way you manage your money during this time by avoiding higher-priced items and cutting back on non-essential purchases that can eat away at your savings. 

If you were just barely making ends meet before inflation, you may need to reduce your living expenses by moving into a less expensive house or getting a roommate. You may also need to increase your income by getting another job or starting a side hustle.

Inflation can have a sizeable effect on your investments as well. When inflation is high, the Federal Reserve may raise interest rates to reduce the money supply and offset the effects of inflation. This will make it more expensive to take out a loan and borrow money.

Any money you have saved won’t be worth as much as it was before inflation. If you store a wad of cash under your mattress as prices continue to rise, the value of your savings will stay the same as the cost of living goes up. 

The same is true when putting your money in a checking account. That’s why it’s important to invest your money in assets with the potential for higher returns. The expected rate of growth should be as close to the rate of inflation as possible, so your savings don’t lose value over time as prices increase.

Many people choose investment products such as mutual funds or invest in the stock market during inflation. These types of investments have higher return rates than traditional savings accounts. However, high-return investments typically come with added risk. The stock market may be increasingly volatile during periods of inflation, so look for investments that aren’t too volatile and tend to do well during inflationary periods.1

How to Manage Your Finances During Inflation

So, what can you do to protect your finances from rising prices? Use this guide to make informed decisions during these stressful times to limit the effects of inflation.

Stay Informed

It’s important to stay on top of inflation as the situation changes by checking the Consumer Price Index. Sudden changes in inflation may affect your financial strategy, so be prepared to change your approach over time. Follow along with how the government is responding to inflation, especially if the Federal Reserve signals that it’s going to raise interest rates.

Buy Now or Buy Later

Many consumers assume that it’s best to buy products with lasting value sooner rather than later before prices increase, such as fuel, oil, gold, silver, non-perishable foods and other essential supplies. This may work well for some people, but you shouldn’t overspend on stocking up items unless they’ll keep their value and/or utility. Your money won’t go as far as it did before inflation, so if you have been considering making a big purchase, you may want to move up the purchase date.

Set a Budget

Your financial situation is bound to change in several ways during inflation. If you are worried about making ends meet, compare your living expenses with your income to see if you will have enough to get by. Create a budget and stick to it.  Check the latest prices on the CPI for the latest numbers.

If you are saving for retirement or your first home, factor inflation into your financial strategy to see how these price increases will affect your plan.

Invest in High-Yield Investments

Putting your money toward high-yield investments with strong growth rates can help offset the effects of inflation. Some people invest money in individual stocks or exchange-traded funds to try and outpace inflation by picking companies that can withstand, if not benefit from, the current economic conditions. Commodities and precious metals, such as gold and silver, also tend to be popular with investors when inflation is rising.

However, all investments come with some level of risk, but diversified funds tend to be less volatile than individual stocks. You can also hedge against inflation by investing in assets that will either maintain or grow in value during inflation, such as I-bonds and other inflation-protected securities. Consult a financial advisor to help determine what investment strategy is most appropriate for your situation.

1 The information provided is for educational purposes only and should not be considered recommendations or advice. Please consult the appropriate financial, tax or legal professional to determine whether the strategies presented in this article are appropriate for your situation.

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