Inflation Is Sky Rocketing – Here’s What You Need To Know
It’s been decades since the U.S. faced double-digit inflation rates, and financial advisors worry that years of small, steady increases may have left consumers unprepared for the extended inflationary environment that may be ahead as inflation rates rise in the U.S. Over the past year, the rate of inflation rose to 5% – the largest 12-month increase in the consumer price index since August 2008. Economists can’t yet be sure whether the sharp increase is the start of a long-term trend or simply a temporary correction following the coronavirus pandemic. But taking steps to hedge against inflation should be part of everyone’s financial plan, whether inflation steadies or continues to ramp up in the coming months. “We’ve been used to a period of time with relatively low inflation, so we’ve all gotten complacent. We’re seeing it now, and economists aren’t surprised necessarily, but a lot of everyday people are,” says David Weliver, personal finance expert and founder of Money Under 30. “The big question on everyone’s mind is, is this the new normal or is this just transitory?”
What Is Inflation? Inflation means consumers can buy less with the same amount of money. The rate of inflation is measured by the consumer price index, which calculates the average change over time in the prices consumers pay for a market basket of goods and services. Inflation typically rises slowly, often unnoticed by consumers. During periods of high inflation, the effects can become more severe, triggering a cycle of rising prices and interest rates while the value of the currency falls. Over the last century, average annual inflation in the U.S. has ranged from upwards of 10% to lows of -10%. Ideally, the Federal Reserve aims to reach a target inflation rate of 2% in the long term. This rate represents a balance between inflation that is too high, causing a burden on families seeking to purchase essentials such as food and gasoline, and inflation that is too low, which can weaken the economy. Gary Zimmerman, managing partner of Six Trees Capital in New York and Founder of MaxMyInterest.com, says today the U.S. is experiencing a “moderately high-risk inflationary environment.”
Why Does Inflation Occur? Today’s inflation is caused by multiple factors, Weliver says, including a sudden demand for goods while supply struggles to keep up amid the pandemic, low interest rates and large amounts of cash in consumer pockets following government stimulus payments. “What happens when you print money is you put more dollars into the supply and the value of each dollar goes down,” Weliver says. “We have these three things going on at once, so not surprisingly, inflation is really starting to pop.” Talk of inflation can be self-fulfilling, Zimmerman says, and though today there may still be time to constrain it, once the ball begins rolling it can be difficult to stop. “In an inflationary environment, the first thing that happens is a company’s costs go up. They pass those costs to customers in the form of higher prices,” he says. “As long as labor market conditions continue to be tight – the very act of people asking for raises, or we’ve seen McDonald’s offering large bonuses to people willing to work – that means they must raise their prices, and so it ripples through the economy. It’s almost inevitable at this point.” In June, the Federal Reserve raised its inflation projections to 3.4% for 2021, but this metric still has inflation rates falling in subsequent years to meet the central bank’s target.
How to Hedge Against Inflation In an inflationary environment, consumers are reminded of an existential truth: Money is a social construct, mere paper assigned a value that can change overnight. Inflation breeds fear, but it doesn’t have to. “Inflation tends to be temporary. Having plans in place can be more long lasting and more effective,” says Nilay Gandhi, a certified financial planner with Vanguard’s Personal Advisor Services. “Sticking to that plan will generally outpace inflation.” As the threat of continued inflation looms, consider these strategies to hedge against inflation: Maintain a budget. Spend less than you earn. Delay purchases of goods severely affected by inflation. Build skills and work toward a promotion or raise to keep up with costs. Set clear, appropriate goals. Maintain a well-balanced, diversified investment portfolio. Choose an asset mix that suits your goals. Stick to the plan. Commodities like gold tend to be considered safe havens in times of high inflation, and this popular belief can be true, Weliver says, but it takes time for such investments to pay off. Typically, commodities should be held as one piece of a larger portfolio. And as inflation rates rise and fall, advisors continue to suggest sticking to a financial plan and following the fundamentals of personal finance, such as spending less than you earn. “Focus on the controlables,” Gandhi says. “Choose an asset mix that’s appropriate for the duration of that goal and the comfort level of ups and downs that could happen with that time frame.”