How to Survive High Inflation

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Investors greatly underestimate the danger of inflation. While it is measured by a rise in prices, inflation is actually a currency’s loss of purchasing power over time. The lifetimes of our elders easily demonstrate this fact.

My great-grandmother Florence Mortlock was born in 1904 and lived to 2004. At the end of her 100-year lifetime, $100,000 had no more purchasing power than $5,000 did when she was born. That is the normal effect of inflation.

Even over the past 32 years, inflation has taken its toll. It takes $22 today to buy what was worth $10 in 1990. Put another way, today’s dollar only buys 45.249% of what it could have in the past.

Inflation is not something that any of us can just wish away. It is an economic condition that ultimately affects the purchasing power of everyone’s cash. It is like the rain. You must prepare in advance — wear rain boots and a rain coat and carry an umbrella — in order to stay dry.

Americans are generally unfamiliar with large purchasing power fluctuations. However, recent conditions are giving a new generation experience with this unfortunate condition. And fortunately for us, there are things that we can do to survive or even thrive during high inflation.

Inflation-Protect Some of Your Bond Allocation

Buying bonds carries at least three risks.

  • First, your purchasing power could be lost through inflation by the time your bond matures. When you get your money back, it won’t buy as much.
  • Second, your bond could be worth less than your purchase price if you need to sell your bond before maturity and interest rates have risen.
  • And third, the bond issuer could default, stop paying interest, and fail to return your investment.

Like stocks, each of these risks can be reduced through diversification by purchasing bonds with different maturities, credit qualities, industries, and countries.

However, you can see that inflation is one of the factors that affect bond pricing. Generally, when inflation rises, bond prices fall and when inflation falls, bond prices rise. This is because inflation makes the $1,000 you are paid back worth less than $1,000 was worth when you bought the bond.

Bonds with longer terms are the most vulnerable to losses from rising inflation. For this reason, it is normally a good idea to stage the next few years of your upcoming withdrawals in short-term bonds while short-term inflation-protected bonds (called TIPS) might be an even better choice.

Treasury inflation-protected securities (TIPS) increase their rate of return by the CPI-U inflation measurement. Semiannually, the bond’s principal increases by the same percentage as the CPI-U index. With the same interest rate, a higher principal means higher dollar-value interest payments.

Staging short-term and inflation-protected securities as a part of your bond allocation makes sense for investors with withdrawal needs.

If you are not anticipating withdrawing from any of your investment accounts over the next 7 years, then you do not need a bond allocation. In fact, even compared to short-term TIPS, a portfolio of stocks is historically more likely to keep up with or surpass inflation.

Pay Minimum on Low-Interest-Rate Debt

Most debt is bad debt, but there are two important exceptions to this rule: home mortgages and student loans. Diligent savers can use these types of debt to their advantage.

If you are capable of generating wealth through diligent saving, having a 30-year fixed mortgage or 10-year fixed student loan at low interest rates are the best hedges against inflation.

During periods of low or moderate inflation, it can be tempting to pay more than the minimum. The sooner you pay off your loans, the sooner you can start building wealth… or so the thinking goes.

In reality, as a rule of thumb, the lower the interest rate, the better off you’ll be just paying the minimum monthly payment and nothing more. Take the extra money you were going to pay on your loan and invest it instead. This rule of thumb can be used as a guide during all seasons, but it is especially true during periods of high inflation.

While your fixed loan payment stays exactly the same, the purchasing power of your currency is changing quickly during sharply rising inflation.

Imagine that you have a mortgage where you are required to pay $1,000 each month. You made the minimum payments during the 12-months of May 2021 through April 2022. Over that time period, inflation was 8.26%. This means that the purchasing power of your money declined over the time period so that a dollar in April 2022 can only buy 92.37% of what it could buy back in May 2021.

Put another way, your past nominal $1,000 May 2021 payment cost you $1,083 of future inflation-adjusted April 2022 dollars. If you had pay $250 more than the minimum one month, it would have cost you $103 more dollars of purchasing power to make that extra payment in May 2021 rather than April 2022.

In this way — even ignoring the opportunity cost of missed investment returns or the intricacies of the amortization schedule — sharply rising inflation makes the fixed payments of today cost you more purchasing power than the same dollar amount of payments in the future.

We can add inflation to the growing list of reasons why you should consider paying only the minimum on your student loans and mortgage.

Ask for a Raise

It can be awkward to negotiate your salary, but during sharply rising inflation it is important . With an 8.26% 12-month inflation, if your salary doesn’t increase, you just got a 7.63% pay cut with respect to purchasing power.

Asking for a raise that, at least, keeps up with recent inflation will make sure that you can still afford your savings and lifestyle.

If for some reason your boss says no, ask what you would need to do to get a raise. Use the response to help you decide whether you need to make a career switch to get the salary you need.

Use Inflation to Tighten Your Spending

High inflation is a chance to tighten your spending.

For example, assuming your salary increases with inflation, if your clothing budget is $50 per month and you don’t increase it while inflation moves, then the percentage you spend on clothes will naturally decrease.

This is a simple way to decrease your spending and increase your savings.

Each of us has a mental concept of how much something costs, and as we face inflation, we can decide how quickly we’d like to update that figure.

Somewhere in the 1990s, I got it into my head that shoes typically cost $20. They don’t any more. They haven’t cost that for a long time. However, I never really updated my mental concept. Instead, I spent twenty years wondering why shoes were so expensive and only the last ten really realizing that, with inflation, the same cheap shoes likely cost at least $40 now.

This type of elective self-delusion helps encourage thrift. If twenty or thirty years later, I’m still anchoring my shoe purchases on $20, then I will be more inclined towards thrifty shoes and finding savings.

On the flip side, somewhere along my meal planning journey, I purchased a book called “Family Feasts for $75 a Week.” It was published in September of 2009. At the time, $75 per week was very doable. These days, $75 is a challenge, but $101 (the inflation-adjusted figure) is still doable. By quickly adjusting my mental concept, I am able to continue to find thrift in my grocery shopping without getting demoralized.

As I discussed in a recent podcast, I like to engage in Core Values Budgeting. In the budgeting strategy, you identify which parts of your spending are the most important to you (the core) and you protect them from budget cuts. You also identify the spending items that are less important to you (the edge), and you cut those items out first.

For me, eating good food is at the core of my budget while purchasing shoes is out on the edge. I want to inflation-adjust my mental concept for groceries and eating out because it is important to me. Meanwhile, I’m happy for my shoe expenditures to decrease as it lags behind the tide of inflation.

Sow Seeds (Literally and Figuratively)

Gardening is a good hedge against high inflation. You buy the seeds today. The price of seeds goes up, but you don’t care, because you already own seeds. You sow those, let’s say, tomato seeds in the ground while the price of tomatoes increases. You don’t care though, you have your homegrown tomatoes to enjoy.

This is an example how purchasing items or investments which maintain their value in the face of inflation can help.

This is one reason why it is important to keep your savings invested in stocks. On average, stock investments appreciate about 6.5% above inflation and bond investments appreciate about 3.0% over inflation.

Meanwhile, cash, which seems very safe, depreciates by inflation. Inflation can average 4.5% annually. By trying to keep your money safe in cash, 4.5% inflation will cause it to lose half of its purchasing power in 16 years. This is why we say that cash is one of the riskiest investments.

Although inflation can be low at times, there is every indication that incentives are in place for higher inflation. Inflation is perhaps the stealthiest tax the government has. First, they tax the capital gains on assets which appreciate with inflation. This generates more revenue. Then, they intentionally exclude technological advances from the CPI, under-reporting real inflation and making government benefits, like Social Security, decrease in value. This cuts costs on their obligations.

In order to balance the risks of inflation, we recommend having an allocation to resource stocks, but not to gold. Gold is very volatile and its expected return is 0% above inflation. By comparison, stocks are less volatile and have a higher mean return.

While we do recommend bonds to stage 7 years of withdrawal needs, investing too much in bonds can mean a lower lifestyle in retirement. We recommend investing just enough in bonds so that we can sleep well tonight knowing that the next several years of spending are invested in stable investments. But we recommend investing the remainder in stocks so that we can continue to eat well in ten years.

We like to say that this type of asset allocation is priceless because while the difference between the returns of an all-bond and an all-stock portfolio can be measured, the value of not running out of money when making withdrawals cannot be measured.

Raise Your Own Prices

The last piece of advice here is to raise your own rates. Small business owners are often slow to keep up with inflation. As inflation drives up prices everywhere else, the small business owner simply gets overworked and starts turning customers away.

If you are turning customers away, it is a sign that you need to raise your rates. The price you are using now is creating a shortage. Demand is outpacing your supply. To find equilibrium with demand at the supply you want to offer, you increase the price.

Increasing your rates can be as tricky as negotiating a salary increase , but it is important during sharp inflation.

Photo by Lerone Pieters on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.