Inflation. These words might give you the chills or just a blank stare, depending on your age. I was born in the late 70′s and don’t remember ever having to deal with high inflation rates. High inflation rates are harmful to the purchasing power of the individual consumer. If there is a 5% annual inflation rate, a $1.00 cup of coffee (I wish) would cost $1.05 the following year.
“The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.”- Investopedia
I believe my time of experiencing low inflation rates will be over soon and a new generation will once again learn how to deal with a high inflationary atmosphere.
Brief History of Inflation in the U.S. and Canada (for those who weren’t there)
In the 1970s the United States and Canada experienced a time of high inflation. It was characterized by gas shortages, high mortgage rates, rising prices, high unemployment, and social change.
Why? It wasn’t just high oil prices, but a poor monetary policy including increasing the national debt and lowering interest rates lead by Nixon and Fed Chairman Arthur Burns (The Great Inflation of the 1970s).
“OPEC got all the credit for what the U.S. had mainly done to itself.” WSJ (1986) via Investopedia
Measures of Inflation (nerd section)
There are different ways to measure inflation: Gross Domestic Product (GDP), Producer Price Index (PPI), Consumer Price Index (CPI), Employment Cost Index (ECI), and even more. The most common measures are generally GDP and CPI, though there is debate amongst economists as to which measure is the best indicator for inflation.
CPI Index from 1914-2012 - These numbers are slightly higher than GDP.
Inflation by GDP: (U.S. and Canada)
High inflation not only effects the U.S., but the whole world market.
Prepare for High Inflation
1. Fix Your Rates- If you have variable interest rates on your credit cards, mortgages, student loans, or private loans–NOW is the time to transfer to fixed interest rates. In a high interest economy variable rates will keep rising, thus increasing your interest and lengthening your time in debt.
2. Cash Reserves- Keep a good stash of cash of cash as your buying power will decrease with inflation. Start with an emergency fund and then grow from there. Check out this cool Inflation Calculator to see how your buying power changes. For fun plug in the numbers for the last car you bought.
3. Buy a House- Interest rates for mortgages are currently at historic rates and will rise quickly. Houses will increase in value as inflation rises, so in a sense you ride the wave of inflation with your largest asset. High interest rates could lock you out of the market, so plan on purchasing sooner than later if you are on the fence.
4. Consider rental property (if you are out of debt and financially stable) and Real Estate Investment Trusts (REIT) for protection against inflation.
5. Invest in I-Bonds or TIPS- Having these in your mix of investments will help protect your portfolio from high inflation. You can cut out the middleman and buy I-bonds directly from Treasury Direct. TIPS can be bought through a variety of ways. It is a good idea to compare TIPS and I-Bonds to see which bond is right for you and always ask your financial advisor if this fits into your overall investing plans.
More Inflation Articles:
- Has Inflation Killed the Need for the Penny? - Miranda Marquit
- Using Your Mortgage as an Inflation Hedge or Pay It Off Early- Kevin Mulligan
- Nominal vs. Real Interest Rate – Effects of Inflation- Kim Petch