Inflation Survival Guide

HomeBudgeting and Saving

Executive summary

Is it a bird? Is it a plane? Nope. It’s just inflation soaring sky high. I’m sure you hear about inflation at least once a day nowadays, as we’re in the midst of a high inflation period and people love to complain. But rightfully so! While a natural part of our economy, inflation can have major consequences for families and their finances.

In this post, we tackle three things on the top of everyone’s mind:

  1. What inflation even means
  2. How it affects you and your finances
  3. How you can protect yourself from rising inflation

In a nutshell: Inflation is when prices of goods and services rise at a rapid rate, outpacing growth in income. Inflation can be detrimental to your savings, your investments, and can increase your taxes. There are many ways to protect yourself from inflation if you’re proactive: diversified investments, TIPs, and I-Bonds to name a few.


For a deeper dive into soaring prices and inflation, check this post out!

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What is inflation?

 Inflation is a hot-topic these days. You hear people complaining about rising inflation everywhere from your local news channel to the family barbeque. It sounds like “Holy [expletive]! Inflation is so bad, I spent $75 at the gas station and couldn’t even fill up my tank”. But what does inflation really mean?

 The word inflation comes from the Latin root flāre, which means “to blow”. Funnily enough, this also happens to be where we get the word flatulence from. However, these two words differ greatly, with one having more serious implications for your financial wellbeing.

 In tightly-wound economic terms, inflation is when your purchasing power decreases due to increasing prices for goods and services, usually measured by the Consumer Price Index (CPI). Put simply, it’s when things cost more than they usually do. As baseball player Sam Ewing described, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” Essentially, every dollar you have today can buy less tomorrow. Obviously, this is not ideal, especially when it comes to your spending, saving, and investing.

 

Current inflation and some contributors

 

In the US, we are experiencing a higher inflation rate than we’ve had in 40 years, but compared to the rest of the world, we’re in the middle of the pack. Inflation is a global phenomenon. So what causes it?

What causes inflation?

Two main things: 

(1) Higher costs for a company force them to push the price up so that they can turn a profit.

(2) Increased demand outpaces the supply of a good or service thus leading to higher prices.  

Causes for the current inflation spike

The image above summarizes the main causes of the inflation we’re experiencing right now. The pandemic led people to have a higher demand for goods and services. The war in Ukraine combined with bad weather and diseased crops led to a reduced supply all around. And with the workforce decreasing in size due to Covid, employers have been forced to increase wages. This leads to the perfect inflation storm of prices increasing all around so that companies can turn a profit.

 Bottom line: higher prices = inflation. While inflation is a normal part of the economy and usually sits around 2%, if inflation gets out of control for prolonged periods of time, there could be consequences for your finances. That’s why we’re here at Steward to help you look out for how inflation affects you and your path to financial freedom.

 

Why should it matter to me?

 Because inflation directly impacts your finances—when prices go up faster than your income can, then we have a problem. 

 One way we can find out exactly how inflation affects you is by calculating your “personal inflation rate”. Inflation varies by geographical location and lifestyle, so the amount of inflation you experience might differ from someone else. To calculate your “personal inflation rate”, you need to (1) pick a month (2) pull up a breakdown of your expenses for that month in 2021 AND 2022 (3) calculate the change from 2021 to 2022 in terms of percentage and (4) do a weighted average of all of the % changes in terms of how much each expense contributes to the total expenses. For a more visual representation of how you’d do this in Excel, see this template from Kitces:

 

Blank template for determining Personal Inflation Rate

 

The “personal inflation rate” can be a good gauge for how much inflation affects compared to the national rate. You’ll likely find that inflation affects almost every area of your finances. There are three main impacted areas that you should be aware of: your savings, your investments, and your taxes. Let’s dive in! 

How much you save

 As we mentioned before, inflation means higher prices. That means that it costs more for your groceries, for gas, for just about everything! But the income you earn is probably the same. Income stays the same, but expenses are going up… this means that the amount of money you’ve been saving goes down. Womp womp. Less savings means a slower road to having the option not to work.

How much your earn on investments

 Inflation can actually hurt your investment earnings. This is due to inflation decreasing your purchasing power and decreasing the value of money overall. This directly affects certain investment assets like bonds and decreases not only their value, but the purchasing power of their future income. Put bluntly, inflation can cause your investments to be way less useful to future you, because everything is so damn expensive.

How much you pay in taxes

 Inflation can cause what’s called “tax bracket creep”. What does that even mean? Well, “tax bracket creep” is when rapid inflation causes your income to rise faster than the threshold for each tax bracket. This means that more of your income will fall into a higher tax bracket and cause your income to be taxed at a higher rate. Ew! At Steward, we’re all about optimizing tax strategy, not paying more than you should be.

 

How do I protect myself from it?

 Now that’s the big question. How do you protect yourself from something that you have no control over as an individual? Here we highlight 5 major to-do items that you can use to be proactive and protected from inflation’s consequences.

1) Right-size your cash

 There is such a thing as having “too much cash”. I was taught by my parents that you should always have a stash of rainy day cash, and that the more I stash away the better. If it’s stashed, it’s safe… right? Well, this old-school mentality can actually hurt you when it comes to inflation because the cash’s savings value will just erode.

2) Revisit your cash flow / savings goals

 Your “personal inflation rate” could look very different from the overall US inflation rate, depending on where you spend your money and what you spend it on. For example, fuel/gas/electricity and cars have had 10x the price bumps compared to other categories (e.g., medical care, clothes, food). By revisiting your goals, you can make sure you’re spending money on the necessities and staying within your budget & savings goals.

 

Inflation by Category

 

3) Check your homeowner’s insurance

 This may seem like an odd ask at first, but it’s important! A lot of times, your current homeowner’s insurance may not be taking into account the inflation that is affecting your everyday life. So to protect yourself and your assets, check your insurance coverage to ensure that you’re not underinsured.

4) Delay Social Security

If you have other means of supporting your retirement life other than Social Security, then putting off its collection can be a smart hedge against inflation. Each year that Social Security is delayed past retirement age, the amount of the eventual benefit increases by 8%. Thus, an individual with a full-retirement-age benefit at 67 years of $1,000 a month could increase their benefit to as much as $1,240 by delaying to age 70—an increase of as much as 24%. Plus, there's an annual Consumer Price Index increase that is based on this higher amount.

The additional amounts can be viewed as equivalent to guaranteed “investment returns” backed by the federal government. They are guaranteed because this growth in the benefit is not subject to market fluctuations. And the longer you live, the greater the returns and increasingly better inflation hedge.

5) Ask for a raise

With the current high inflation rate, it might be the right time for you to bargain. The salary increases one normally gets are likely to be below the rate of inflation, so it is important to ask for higher raises. Studies on financial literacy show that most people think in nominal rather than real terms (plain-talk: people think in terms of the actual money they have vs the purchasing power of the money after taking inflation into account). Without an increase in salary that matches the rate of inflation, one is losing purchasing power. Given the state of the labor market, summon up the courage and ask for the raise. You need it.

6) Beware of "shrinkation"

You may have heard of inflation, but have you ever heard of "shrinkflation".

Essentially, product companies will slowly “shrink” the contents of the packages and goods you buy while charging you the same price. This means a price hike for you. Your bag of chips now has more air and less chip. A box of cookies now has 3 less cookies. Toilet paper rolls now have 240 sheets instead of 246. It's robbery! And this doesn't just apply to groceries. "Shrinkflation" affects eating out at restaurant too! You cacio e pepe at your favorite Italian place might now have 2 ounces less cacio and half the pepe.

One way to deal with shrinkflation is to try to stick with generic store brands because those tend to be the last to shrink. Additionally, pay attention to the unit price of what you are buying. It also helps to only buy fruits and vegetables that are in season.

7) Avoid knee-jerk reactions

 The market is currently predicting future inflation to be 2.56% (as of July 2022, using the TIPS breakeven rate). And in the 20-plus years of data we have since the introduction of TIPS in 1997, the market has consistently overestimated the rate of inflation. So avoid doing anything rash or something you might regret. Ensure you’re protecting yourself, and brave the storm.

8) Stay diversified and consider the following investments

In any given year, one index can outperform the other. Diversifying is the best hedge.

 

Diversified investments are one of the best ways to protect yourself from inflation and a turbulent market. Take the guesswork out of investing by diversifying your portfolio broadly across investment types and geographies. Doing this vs. trying to pick individual winners will set you up for long term success. If you are extremely lucky, you might find the needle in the haystack of investments that brings you an extremely high return one year. But you can’t rely on those odds when it comes to your retirement. It’s a gamble. And the safest way to protect yourself from the risks and the erosion of investments that comes with inflation is to diversify.

 

This bar chart showcases the returns of various investment types in times of high inflation. The takeaway: It’s safer to have a mix.

Another way to diversify your portfolio is through target date funds. A target date fund is a type of fund that shifts your asset allocation over time based on the “target date” you set. Usually used for retirement, these funds will adjust your diversification and risk based on how fast the target date is approaching. Check out Vanguard’s target retirement funds here

There’s no one panacea to survive inflation, but the best long-term inflation-resistant investments are under the radar (e.g., i-bonds, a diversified stock portfolio etc.). Many purported “inflation-fighters” aren’t great hedges afterall. More on that below:

 Here are what we call “proceed with caution” assets that you could use to diversify your portfolio—but you should approach them with a grain of salt:

I-Bonds. What are they? An I-Bond is an inflation-protected US savings bond, with the US government guaranteeing you get your initial investment back with a solid rate. In 2022, I-bonds have a 9.62% annual rate, which is incredible! It sounds like a scam but it’s not! They are a really well-kept secret amongst financial advisors, because advisors have no incentive to sell them. Additionally, interest on I-Bonds is exempt from state and local taxes. So they have a great return & have a great tax benefit. Is this too good to be true? The caveats with I-Bonds is that you can only purchase $10,000 in I-Bonds per person or entity per year, and there is an interest penalty if bonds are redeemed in the first 5 years. But they’re still an incredible tool to help you achieve the net worth you’ve always dreamed of! To learn more about I-Bonds, feel free to read this WSJ article by Jason Zweig which summarizes just how awesome I-Bonds are. 

 You can buy I-Bonds directly from the Treasury here, and you can also check out this Bankrate article here for a step-by-step guide to buying I-Bonds.. 

  

Some other “proceed with caution” assets are alternative assets and they include: commodities, cryptocurrencies, and real estate investment trusts (REITs). Assets like these are often good hedges against inflation, but they also have their risks. 

REITs have a relatively consistent track record of outperformance against inflation, but conflating factors could make them less effective. For example, rising interest rates and a sluggish economy reducing demand could weaken their performance. Also, they are illiquid and have high expenses that might make it not worth the protection. 

Energy, Commodities (like gold, lumber, oil, grain etc.) and Cryptocurrencies are seen as good protection due to their quantified, limited supply. For example, there is only a certain amount of gold on Earth, and crypto like Bitcoin is capped at 21 million coins. This should theoretically mean that these assets hold their value even when the US dollar declines due to inflation. However, these assets are good protection against long-term unexpected increases in inflation, as their price already bakes in the market’s expectation for future inflation. It’s important to note that both energy and commodities lost money in inflationary years of 1998, 2001, 2008, 2014, 2015, 2018 and 2020. In 4 of those years, they lost more than 10%... so proceeding with caution is the best way to ensure you don’t hurt yourself financially. 

Treasury Inflation Protected Securities (TIPS) are also another common protection against inflation. I mean it’s in the name, right? TIPS are government-issued debt with interest payments tied to the ever-changing inflation rate. You can purchase them directly from the Treasury Department here. While they may seem like a no-brainer, there are actually some strings attached to keep in mind. Because so many people use TIPS to protect against inflation, there is a high price point for these securities. Put simply, they’re not cheap, and can incur significant losses if interest rates rise or inflation is less than expected—which would reduce/negate the benefit of their protection. They are, in fact, really nice inflation products, but it’s the type of investment where it would have been nice to invest in them a year ago. Since we’re in the midst of high inflation, we might be a little late to the party when it comes to this protection method.

Value Stocks are stocks which trade at low prices relative to their assets or earnings. They’re less reliant on tomorrow’s earnings than growth stocks are. Value stocks worked well as inflation-fighters in the 1940s/70s/80s and 2000s. They performed well in the high-inflation years of the 1970s, following the removal of the U.S. dollar from the gold standard, but since then, they have lagged in both high and low inflation environments. Therefore, caution is advised.

 

Want to learn more about how to protect yourself from inflation?

 Steward ‘s mission is opening up the 1%’s wealth strategies to America’s up-and-coming families with a combination of 21st century tech and trusted advisors. We help families determine how, where, and when to invest and save on taxes in plain-English, with minimal time and effort. Steward can help determine if inflation is affecting you and your finances, and can advise on how to prevent it from halting your growth and path to financial freedom. Give it a try here.

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Written by Ami Shah and Ilija Wan-Simm

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