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The consumer price index rose 7% in 2021, the largest 12-month gain since 1982. So far, it has not eased in 2022, and most forecasts expect it to stay elevated for the rest of the year. So, what does this mean for most Americans?
The answer depends on the response of businesses and the Fed. First, the Fed will raise interest rates this year, the only question is how quickly they move. The reaction of business is more uncertain, especially as of late. Almost all businesses are facing steep rises in inputs, particularly the cost of labor.
Those that produce goods are being hit with the double whammy of a higher wage bill and higher input costs. In other words, the price of the services and goods they provide is going to have to rise, too. Some companies are luckily still sitting on quite large cash reserves. If they think it will help them retain market share, they might use this cash buffer to dampen price hikes. However, the extended inflation outlook diminishes the appeal of this strategy to all but a few firms.
The other business ‘unknown’ is whether and how much your employer will increase your pay. If history is any guide, expect this to be lower and slower than your increase in living expenses. In other words, expect higher prices for most goods and an increase in interest rates later in this year.
The impact of higher prices in your life is an obvious negative. The impact of higher interest rates is more nuanced. Most Americans owe debt. The good news is that inflation will lower the real value of your debt repayment, as the money you are repaying is worth less than money you already spent.
This only relates to repayment of principal though. If you have debt with a fixed interest rate (say on your mortgage) you are in a good spot. The real value of the money you send to your creditor will go down. If you have a flexible/floating/variable rate, this will rise with the Fed’s moves and the real value of your credit payment will probably go up. This is especially true if you are in the early stages of a car/house loan when your payments are mainly interest not principal.
And credit cards? If you are not paying off your credit balance in full each month, then you are paying mostly interest and again expect this number to go north.
On topic: Investing Your Money for a Higher Return
Higher interest rates will also dent your savings accounts and portfolio. The rate on your savings account may rise slightly but likely far less than the inflation rate. Your portfolio? If you ignore other factors, higher interest rates lower the price of your bonds and can ding your stocks as well.
For those living on a fixed income such as many new/current retirees, this is not good news. It is definitely a good moment to be careful with your spending and look for ways to cut back. For those still building their wealth, consider some inflation protected assets. Investigate things like Real Estate Investment Trusts (REITs), especially ones that have deep cash reserves. REITs get their income from rents and property prices which go up during periods of high inflation.
Those with more cash will not have to rely on debt-funded property acquisitions at a time of rising interest rates. Stocks and funds to consider during inflationary periods are those exposed to commodities and banks. Both of these sectors tend to do better than others when prices are rising. Quality and exposure vary, so research your planned purchases carefully before taking the plunge.
For those wanting less risk, Treasury Inflation-Protected Securities (TIPS) are an option. Both the principal and the interest of these rise as inflation does, so although they will cost more, they will net more income too. You can buy these directly at treasurydirect.gov.
If you want a stable, long term investment instead, you can look at Series I bonds. The initial rate of interest is around 7% and the rate adjusts every six months based on the CPI. You cannot redeem the bond during the first year, and if you cash it in during the first five years, you pay three months worth of interest as a penalty.
A Series I investment will earn you far more than current bank certificates of deposit and has a much lower penalty! You can buy up to $10,000 electronic I bonds at the treasury direct website and up to $5,000 paper bonds with your federal tax refund.
Even better, you don’t pay state or local tax on the interest and you can defer federal tax until you sell it! An inflationary world is not a pretty one, but as you can see, there are ways to fight back and come out financially stronger.
Want more financial tips? Check out Greenwood Daily with Greenwood’s Certified Financial Planner, Rianka R. Dorsainvil, CFP®.
About the Author:
Krista Tuomi is a professor in the International Economic Policy program at School of International Service, American University. She has worked for many years as a policy analyst in the areas of innovation and investment. Her regular Bizwomen column, media interviews, and research focus on topics that include angel investing, crowdfunding, non-profit management and fundraising.
She also conducts workshops in the US and abroad on all forms of small business and non-profit financing. Her passion for the field of innovation and entrepreneurship extends to her pro-bono work.
Currently, she works with SCORE, Greenwood, Boots to Business, Martha’s Table, Black Girl Ventures, Syracuse’s Institute for Veterans and Military Families, and the Angel Capital Association.