In this article we're going to talk about inflation, its causes, what the Federal Reserve is doing about it, and most importantly, strategies for protecting our finances during these periods of high inflation.
What is inflation and what causes it?
Inflation is the rate at which the general level of prices for goods and services is rising. It affects us all in different ways, and we may not always be aware of it. For example, the costs of medical care or the costs of education tend to rise at a much higher rate than regular consumer goods inflation.
One of the biggest pressures on inflation is wages. About 70% of the expenses of a corporation are due to payroll. We’ve been at historically low levels of unemployment, meaning high levels of employment.
Additionally, we’ve been in a historically low-interest-rate environment. And super-low interest rates can lead to inflation. Tack on the supply chain disruptions caused by the pandemic and world events, and now really strong demand as we come out of lockdown, and it’s not a surprise that we’re experiencing such high inflation right now.
The Federal Reserve's response to inflation
The Federal Reserve has several tools at its disposal to manage inflation, including raising interest rates. When the Federal Reserve raises interest rates, it becomes more expensive for banks to borrow money, which in turn leads to higher interest rates for loans such as mortgages.
This can help to cool off demand and potentially ease inflationary pressures.
However, raising interest rates can also have negative effects on the economy, such as slowing down economic growth and increasing unemployment. The Federal Reserve has a delicate tight rope to walk and frankly will never get it exactly right.
As of right now, the fed has raised rates 10 times, and we are seeing signs of cooling inflation. As of their last meeting, they indicated that they are going to hold rates steady for a little bit, and that we shouldn’t expect them to lower rates before the end of the year.
When we have periods of high inflation, we have to understand that certain investments are going to do better than others. As consumers, we still spend the same amount of money, we just spend it on different things.
We still buy essentials like bread, milk, butter, and eggs at the grocery store, shampoo, conditioner, and of course, toilet paper. When prices get high, we may cut back on discretionary items like going out to restaurants or scaling back our travel plans.
Strategies for protecting your finances against inflation
Have a financial plan in place that has a component for inflation. If you work with a financial advisor, they can help you do this and run different scenarios with different inflation assumptions for different types of expenses.
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Step 1: Plan Your Sources of Income
Step 2: Identify Your Expenses
Step 3: Putting it all Together
Invest in a diverse portfolio of asset classes, equities, and fixed income, especially if you own mutual funds. The portfolio managers know what’s happening with respect to inflation and the economy, and they will position their portfolios to account for what’s going on.
Don't panic, everything is going to be okay. We are going to get through this period. The economy is fundamentally sound. Don’t make a long-term decision to a short-term situation.
In conclusion, understanding inflation is crucial for protecting our financial security. By knowing what causes inflation, what the Federal Reserve is doing about it, and how to protect our finances against inflation, we can make informed decisions that will help us navigate these periods of high inflation.