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Inflation and Your Cash Flow: Why It Matters and What You Can Do

I love peanut butter. I’ve always loved peanut butter. As a growing 13-year old during the late 1970’s, I remember going through a couple of jars of peanut butter each month. My mom would bring home a fresh jar and I remember regularly noticing the price on the new jar being a lot higher than the empty one, even though it had only been a few weeks. The inflation rate was very high in the late 1970’s.

Fast forward around four decades or so and it’s happening again today. You may have noticed that peanut butter, pasta sauce and a lot of other things have suddenly gotten more expensive than they used to be. The inflation rate in the US recently hit a 40-year high, with the overall increase in prices clocking in at a staggering 7.5% year-over-year increase. This means that the cost of everything from eggs and meat to used cars and your electricity bill has gone up, leaving many families wondering how to make ends meet and when it will end.

What is inflation?

In its simplest form, inflation is the general increase in the prices of goods and services over time. For example, it’s the reason why your parents and grandparents used to go to the movies for just a quarter, and now you’re paying $10-15 per ticket. 

While several factors could cause inflation, higher inflation can often result when a government, in an attempt to stimulate or support the economy, makes borrowing conditions very easy and expands the monetary system, commonly called “printing” money. About $3 trillion dollars went into the US economy as a result of COVID. In fact, about 40% of all US dollars in existence today were printed in the past couple of years.

As consumers and investors have plenty of access to a lot of cash and credit, they begin to buy up goods, services, and investments at an above-average rate. This can cause businesses to increase prices due to an abundance of demand which could also lead to a lack of supply. For instance, greater demand for homes has caused home prices to rise. Increased demand has resulted in fewer houses for sale. The low inventory or lower supply of houses has then, in sort of a vicious circle, further exacerbated the price/inflation problem.

Generally, prices of goods and services go up over time, with average inflation typically coming in around 2-3% per year. That said, when inflation heats up, and prices rise faster than 2-3% per year, it starts to impact people’s monthly budget and cash flow.

How does inflation impact your cash flow?

Inflation’s impact on your cash flow is like the effect of compound interest on your investments: you don’t notice it right away, but over time, the results can be staggering.

As prices go up, you may not even notice it as you grab a few things off the shelf at the grocery store—an extra dollar here, 20 cents there, and so on. But, suddenly, you go to checkout, and your usual $80 grocery run is coming in closer to $110. And then it stays that way, week after week, with prices either climbing, like my peanut butter did in the late 70’s or staying consistently higher than they were before. 

And it doesn’t end at the supermarket—prices have gone up faster than average for fuel, utilities, cars, clothing, furniture, and even rent. When you add all these up, it can take a toll on a family’s budget, especially for retirees living on a fixed income. Inflation chips away at your purchasing power, giving you less bang for each buck that you are spending.

And unfortunately, wage increases have not kept pace with these above-average inflation rates, meaning that the majority of people’s incomes are not keeping up with these new higher prices. 

Is inflation here to stay?

Right now, the big debate in the financial world is whether this rate of inflation is a short-term phenomenon or if it is something we need to be worried about long-term. Initially, the Federal Reserve came out and said No worries, this rate of inflation is transitory, and we don’t expect it to continue for long.

Unfortunately, it appears the Federal Reserve was wrong, and they have now shifted focus to aggressively curbing inflation to stabilize prices. That means the Federal Reserve will likely raise interest rates multiple times throughout the year to cool off the hot economy. 

While this is great on the one hand and could result in lower levels of inflation perhaps later in the year or sometime next year, it also creates a delicate balance situation. As the Federal Reserve raises rates, they need to be mindful that they do not raise them too quickly, as that could trigger an economic pullback, ultimately leading to a recession. 

That said, the bottom line is that inflation is bad for the average American family. It is eroding their buying power and squeezing their pocketbooks, and the Federal Reserve is focused on slowing it down.

What can you do about it?

Naturally, this may leave you wondering what you can do to avoid the impacts of inflation on your cash flow. Here are a couple of thoughts:

  1. Be mindful of your spending. While inflation has increased 7.5% overall, that can show up as a 20% increase in the price of used cars and maybe a 6% increase in the price of milk. So this is an excellent time to look at the price tag before you buy something and determine whether you really need it right now and if it is worth the amount you will pay. 
  1. Understand your investments. Another interesting aspect of inflation is that, in general, as companies experience higher costs, in turn, they will often pass the costs to the consumer in the form of higher prices. This can ultimately lead to higher overall revenues for certain businesses, boosting their annual profits. Therefore, as an investor, it can be a great time to own particular stocks that could benefit from this increase in prices.
  1. Consider trimming non-essentials. For some families, inflation has created a situation where they may not make ends meet each month. For others, it may mean that they cannot reach their usual savings or investing goals and are maybe even drawing down on their emergency funds. As such, it may be a time to consider trimming some of the non-essential purchases from the budget, at least until the Federal Reserve can get a handle on the price increases and stabilize inflation.

I’m here to help.

As a Financial Advisor and CFP® practitioner with over three and a half decades of experience, I have seen and understand the impact inflation can have on people’s cash flow. People in retirement or near retirement have unique issues to deal with when it comes to inflation. That’s why I work with clients to develop an inflation-adjusted financial plan that includes every aspect of their financial life, from cash flow to investments and even risk management, and help them understand adjustments they can make during periods of high inflation.

If you’re interested in connecting for a complimentary call to discuss your financial situation and the impact of inflation on your plan, then visit Schedule Time With Steve to get scheduled today.

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