A collector bought some lego sets, thinking that they would increase in value over time. Years later, he went to the store, only to discover that many more sets had been produced than initially predicted. What he thought would be worth a lot of money because of its rarity turned out to be worth less than when he had bought them.
Inflation plays a similar role, except instead of decreasing the value of the things we buy, it decreases the value of the dollars we use.
What is inflation?
Think of inflation like the law of supply and demand. When there is a greater supply of dollars without a greater demand, their value drops. Inflation gets its name because the amount of money in circulation starts to blow up, like a balloon.
As inflation rises, so do the prices for things we normally buy. You might notice that products at the grocery store are more expensive. Sometimes, brands will adjust for inflation by decreasing the size of their product, while keeping the same price. Next time you go to the store, pay attention to the prices and sizes of products you're buying. You might notice some changes.
Photo by Niklas Kickl on Unsplash
Who does Inflation affect the most?
If goods and services are increasing in price, the people who will be most affected are those without the ability to increase their income. The largest population of these people are retirees, who often live on a fixed income.
For example, many people purchase annuities because they value the stability of a fixed income throughout their retirement. However, if the payments don’t increase over time with inflation, the retiree could find themselves in a tight spot after a few years.
For this reason, many people consider inflation to be the greatest risk to their retirement. As inflation is due to spike later in the year, many people in retirement are justifiably worried about what that could mean for their quality of life.
What opportunities does inflation provide?
Let’s not think of inflation as entirely negative, though. In fact, there are many reasons why economists advocate for a constant low level of inflation.
A low level of inflation encourages spending. It’s better to spend the money you have now, before it becomes worth less. In this way, trade increases, which increases jobs and quality of life. Said a different way, if prices for goods increase, it’s better to spend money now rather than wait until the products are more expensive.
As the value of the dollar goes down, those with fixed-rate debts might find themselves breathing a sigh of relief. As time goes on, these people will find themselves having an easier and easier time paying off the balance of those loans.
In this way, inflation promotes borrowing and lending. This increases spending as well, which increases demand and production, and boosts the economy.
As the Fed targets a 2% annual inflation rate, this could be a good opportunity for those buying a house or refinancing with a 30-year fixed-rate mortgage.
How can you protect yourself from inflation?
As the value of money goes down, it’s important to own assets that maintain their value so your wealth can maintain its purchasing power. Real Estate, stocks, and even gold can hold value as the dollar weakens.
Another tool that many don’t know about are Treasury Inflation Protected Securities (TIPS). These are bonds from the US government whose value increases along with inflation. These provide the security of government bonds, along with the assurance that your purchasing power will not decrease due to inflation.
What should you do next?
Using inflation to your benefit while also protecting yourself from its risks can be tricky. Sign up for a free Bronze Account and meet with a licensed financial advisor who can help you craft a plan for your specific circumstances.