How to Manage the Effects of Inflation on Your Family

Are you worried about how inflation will impact your family finances?

Inflation is a general increase in the level of prices over a given period of time. With inflation, the same amount of money buys less than in the past, which decreases consumers’ purchasing power. It helps to think of inflation as a process that erodes the value of money.

Different goods and services may have different inflation rates, and price increases can be influenced by supply and demand or a decrease in the perceived worth of the dollar. As a thought experiment, imagine if suddenly every dollar everyone owned became two dollars. We’d expect the price of products to increase rapidly (if not double) as the amount of stuff to buy remained stable while the supply of money doubled. An increase in the money supply is often a major underlying cause of inflation.

With the significant inflation we’ve experienced over the last year, how can a family cope? In a sentence: Increase your income, decrease spending and get smart about the impacts of inflation on your assets, savings and retirement investments.

On the income side, consider asking for a raise or finding a new job that pays more. The job market has seen significant changes in the last few years — maybe there is a better opportunity out there for you.

If you own or run a business, you can lock in prices by buying inventory earlier rather than later. You can also raise the prices of your products or services to keep pace with inflation.

As to spending less, alter your buying patterns to stick to items whose prices have remained stable. This strategy will be especially handy at the grocery store, as consumers have seen their grocery bills rocket up. You can also review your general spending patterns and create a new family budget that accounts for inflation.

Another strategy for facing inflation is preserving the value of your assets. Although it is not a certainty, tangible, long-lasting items such as diamonds and real estate are often better at keeping their value during inflationary times. Consider what assets you hold and whether to exchange intangible assets for more concrete ones.

Next, make sure you invest your savings at decent returns. Over the last year, many families realized that their bank savings accounts paid much less than 1% interest. Finding 4% interest rates is now relatively easy. Check out the high-yield savings account options to ensure you aren’t missing out on extra earnings.

Some investments adjust for inflation, such as I Bonds and Treasury Inflation-Protected Securities (TIPS). In the long term, global stocks tend to at least keep up with inflation, while fixed income suffers.

Yet another consideration is the erosive effect of inflation on your retirement income. While Social Security is indexed to inflation, many pensions are not. If you are retiring with such a pension, it’s important to understand that the purchasing power of a fixed amount of money every year becomes worth less and less over time. It is not unreasonable to assume that the value of a steady stream of income could drop by more than 30% or more over 20 years. What you have saved and invested for retirement must increase in value by the inflation rate (and some taxes) to maintain your ability to spend the same amount of money in retirement. Investing your retirement savings in assets that can’t keep up with inflation is a recipe for late financial stress. Review your investments to ensure they can ride the wave of inflation.

If inflation is significant and long-lasting, using these ideas can pay off in a big way. Find your CFP® professional today to help you get started.