With the Consumer Price Index showing an increase by 8.5% over twelve months, consumers are looking to absorb the shock to their wallets. Rising prices however are not the only factor. Inflation can have a considerable impact on your financial situation.
The best way to prepare for inflation is to settle any outstanding accounts, diversify your portfolio to anticipate rising interest rates, and delay major purchases until prices come down.
Understanding the full impact of price increases, preparing for changes in vendor and distributor behavior, and planning for increasing interest rates can prove daunting if they are not pursued aggressively. Read on to learn where to begin.
Immediate Actions to Prepare
Regardless of your financial situation, there are simple steps you can follow to stretch the dollar in your day-to-day life. These include:
- Buying nonperishables in bulk to avoid future price increases
- Reducing excess recreational spending
- Buying assets to avoid holding excess cash
For some jobs, wages are pegged to the current rate of inflation and will rise with the increase in cost of living. This is not the case for all jobs, so determining whether this is the case for you is essential as soon as possible.
If you support children or other dependents on your income, ensure that you still have an adequate cash reserve so that you can support them in their hour of need. Though cash reserves tend to lose value during inflation, your present needs still apply.
After you’ve taken care of the obvious, planning for your immediate future is the next thing to worry about to prepare for inflation.
Delay Major Purchases to Mitigate Inflation
Major purchases like vehicles, weddings, and houses are unwise during periods of inflation because the price they are agreed upon will maintain once prices come down, leaving you with unnecessary liability.
Especially when major purchases involve taking on additional debt, it is essential to carefully consider the timing and necessity before moving forward. If the purchase is unavoidable, mitigating the amount of debt can be the next best option.
Inflation eventually comes down due to aggressive activity from the Federal Reserve. You should consider how you will feel about these purchases once inflation comes down before you make them.
Preparing For Inflation: Settling Accounts
Consumers are not the only party affected by inflation even though the Consumer Price Index is the primary metric most often used. Vendors and distributors change their behavior markedly.
It is not uncommon for vendors and distributors to delay paying invoices to maximize their bottom line. If you or your business are expecting payments, start holding them accountable today rather than waiting for them to pay on their own schedule.
Many businesses will go under in periods of inflation for reasons we will explain later. Because businesses are operating in a period of flux, it is not possible to count on outstanding payments or purchases just because they are under contract.
The only balance you can truly count on in periods of inflation is the balance in your bank account or your business’ treasury account.
Here are some examples of accounts which are in your best interest to settle as soon as possible:
- Suppliers – If your business is looking to find new suppliers or if your current contracts are nearing completion, consider renegotiating or finding new suppliers and agreeing to a longer commitment to resist price increases.
- Customers – It is necessary to increase prices reasonably to ensure you are not absorbing the full cost of inflation. Emphasize non price-related factors like customer service or quality assurance to increase customer retention.
- Collections – Outstanding balances you’ve been worried about before inflation are not more likely to be paid during inflation. Delinquency rates will increase, so settling collections sooner is always better than later.
- Adjustable rates – The interest rates on credit cards, mortgages and other debts will increase if they are not subject to fixed rates in the present. If you have any adjustable debts or expenses, consider settling them sooner rather than later.
Adjustable rates in particular are tied to broader trends in interest rates that are affected by inflation. These can have consequences not just in evaluating the present, but also in planning for your future.
How Inflation Affects Your Portfolio
The Federal Reserve often increases interest rates during periods of inflation, making borrowing money expensive. This is done to counter the impact inflation has on bonds, since fixed-rate bonds and securities are heavily devalued by inflation.
The reason for this is intuitive – if the rate of inflation outpaces the rate of a bond or security, the holder of the bonds or securities will effectively be losing money at the rate of the difference between the two rates.
This is why we wanted to settle for longer-term, fixed accounts earlier to save money.
Changing your investment strategy to outpace or keep pegged to inflation is an important option to ensure your long-term financial planning stays on track with your target goals. Below are some examples of investments to do this.
Warren Buffett Explains How To Invest During High Inflation
Treasury Investment Protected Securities
Treasury Investment Protected Securities are a type of investment offered by the US Treasury to incentivize lending during periods of inflation.
Rather than adjusting the rate that the bonds pay, the principal on the loan is pegged to the Consumer Price Index to minimize the loss to the investor.
Because these are backed by the government, these are considered low risk options for future investment. Other options have the potential to deliver higher returns than Treasury Investment Protected Securities, but also carry higher risk.
Stocks and Bonds
Stocks with high growth potential and in sectors that can easily pass on risk to customers are good options for investment during inflation.
The key as mentioned before is to find stocks with a high potential to outpace inflation so that the value of the investment is preserved.
Junk bonds with high yield can also be a good option, but carry more volatility. Debts with higher yield tend to increase in value during inflation unlike fixed income bonds and securities.
It is worth noting that most stocks and bonds decrease in value because of the pressures from rising interest rates set by the Federal Reserve.
Real Estate
Real estate is a good option during inflation because it is known to hold and even increase in value as well as offer adjustable income such as rents.
If you currently have any rental properties, increasing the rent during inflationary periods is a sound option in absorbing the cost.
If you do not directly own real estate, other ways to get exposure include investing in Real Estate Investment Trusts (REITs) and other specialized funds that generate a return on your investment as real estate prices increase.
Real estate is still subject to increasing interest rates, so in some cases it is not a good investment in inflationary periods. It is imperative you use your own discretion in evaluating real estate as an investment.
Commodities and Alternatives
Common options outside of the above include investing in gold, wine, art, cryptocurrency, oil and many others. As these commodities increase in price, various investment vehicles will generate a return in addition to buying and holding them directly.
The most common investment options for exposure to an increasing commodity price are Exchange Traded Funds (ETFs) which own the underlying asset themselves.
Various mutual funds are as well as trade commodities, so these can also be a good option. Futures contracts also can provide exposure to the increasing price of a commodity.
It is especially important in picking investments for your portfolio to exercise your own judgment and not go beyond your risk tolerance just because of inflation. Prices do eventually come down, so making drastic changes is not always prudent.
Conclusion
The costs of inflation can affect past, present and future obligations both positively and negatively. Everyone can afford to minimize potential risks and prepare. In all cases, the individual must evaluate the options best for their own situation.
