If you’ve pumped gas, bought groceries, traveled or dined out in recent months, you don’t need me to tell you that inflation is having a significant impact on your purchasing power. While many of today’s workers have never seen inflation this high during their lifetimes, most people in or nearing retirement age remember it well. In fact, I was just beginning my career as a wealth advisor the last time we experienced rates this high. Yet, the current rate of 8.3% pales in comparison to the rates we saw in the late 1970s and early 1980s. By 1980, inflation had topped 14%, and unemployment was over 7.5%, based on historical data from the Federal Reserve (Fed). While most economists do not expect broad inflation measures to reach double-digits, the current environment has been challenging for many individuals and families trying to find creative ways to make their budgets stretch further. Because the forces behind inflation are complicated, it’s important to understand what’s driving it, so you can make informed decisions about your finances going forward. That begins with debunking some common myths that have been making the rounds in recent months.
MYTH 1: Higher prices cause inflation – While higher prices and inflation go hand-in-hand, rising consumer prices, as measured by the Consumer Price Index (CPI), are a symptom of inflation—not the cause. Keep in mind, prices rise over time, even in low-inflation environments. The underlying cause of inflation is an increase in the money supply. In other words, when more money is chasing the same supply of goods and services, that creates greater demand. We saw that during the first two years of the pandemic. Household savings increased as spending decreased things like dining out, travel, entertainment, commuter costs, childcare etc. Government stimulus programs, including economic impact payments also contributed to the rise in personal savings. Once the economy began to reopen, consumers were not only flush with cash, but eager to spend it, which increased demand across a broad range of products and services. However, supply chain issues and labor shortages limited the availability of many goods and services, which helped to drive up prices.
MYTH 2: Rising wages drive inflation – Again, rising wages are a symptom rather than a cause. Labor shortages, like we continue to see in many sectors of the economy, drive up wages. The more businesses have to pay for labor, the more those costs get passed along to consumers in the way of price hikes.
MYTH 3: We’re headed toward a period of stagflation –Stagflation, which we saw throughout the 1970s, refers to an economy that is marked by inflation, a slow or stagnant economic growth rate, and a relatively high unemployment rate. There are many reasons why inflation is different today than it was in the 70s and 80s. Forty years ago, the Fed took a very aggressive approach to tamping down inflation by driving interest rates sky high. By 1981, mortgage rates topped 18%, which had a negative effect on the housing market as financing a home became unaffordable for many potential buyers. Economic conditions today are different. During the pandemic, interest rates went to near-zero. So even if the Fed were to raise rates several times this year to by 2% or so, credit would remain cheap by historical standards. According to the U.S. Bureau of Labor Statistics, unemployment in April of 2022 was just 3.6%, versus more than twice that in 1980, and the labor market continues to show signs of strengthening as job openings continue to outnumber job seekers by almost two-to-one.
MYTH 4: Oil prices are to blame – Since crude oil is a major economic input, a rise in oil prices will contribute to inflation, but it’s not the singular cause. Demand for oil dropped considerably during the early months of the pandemic. However, as the economy reopened, shipping and manufacturing began to come back online, and people started to travel again, demand for oil increased. The combination of demand, fears of supply disruptions, and the war in Ukraine have all contributed to the high fuel prices we’re seeing today.
MYTH 5: It’s a uniquely American problem – While the U.S. saw some of the earliest jumps in inflation last fall, inflation is a global problem. In May, inflation in the eurozone area hit its highest annual level since the creation of the euro currency in 1999, due to a record run-up in energy and food prices stoked by the war in Ukraine. Annual inflation in the nineteen countries that use the euro currency jumped to a record 8.1% percent in May, from 7.4% in April. In comparison, inflation in the United States was 8.3% in April, a slight moderation from previous months.
MYTH 6: Inflation negatively impacts retirees– There’s no question that inflation can negatively impact retirees, especially those living on fixed incomes, by reducing their purchasing power. However, certain measures used to combat inflation can actually help to offset some of the challenges posed by rising prices. Because retirees tend to hold a percentage of their assets in cash to pay for daily living expenses, many will see benefits as the Fed raises interest rates in an attempt to beat back inflation. As rates rise, earnings on cash and fixed income investments tend to rise, which can help provide a counterbalance against the rising cost of consumer goods. In addition, retirees may have more flexibility when it to comes to managing spending on things like gas consumption because they’re not commuting to work. They may also be in a position to exercise greater discretion when it comes to leisure travel or other spending, such as traveling during the off-season, if they’re looking to save on fuel costs or airfare. Those who bought a home or refinanced a mortgage in recent years were also able to lock in historically low mortgage rates. However, one area that impacts nearly all retirees is rising healthcare costs, including hospital, prescription drug, insurance premiums and long-term care expenses.
What can you do to help manage the impact of inflation on your finances?
It can be unsettling when rent, food, fuel and other expenses rise faster than your income or investment returns. However there are many ways to help protect against the adverse impacts of inflation on your finances and investments. For example, historically, investments such as precious metals, commodities, large-company “blue chip” stocks, I-bonds and real estate investment trusts (REITs) have held their value better than riskier assets during higher inflationary periods. While bond values tend to fall when interest rates rise, their yields increase.
If you have adequate emergency savings, you may want to consider investing a portion of those funds in certificates of deposit (CDs) or money market funds that offer higher interest rates than may be available in a traditional bank savings account. And don’t forget about your budget. A review of your budget may reveal ways you can cut certain discretionary spending or delay large purchases until inflation begins to subside.
Before making changes to your strategy or investment portfolio, schedule time to speak with an independent wealth advisor who can help you put a plan in place that considers inflationary pressure in line with your financial goals. To learn more about how to create and maintain a portfolio aligned with specific goals and objectives while seeking to manage risks like inflation market volatility and rising healthcare expenses, download our free guide: The Importance of Process in Your Investment Strategy.