Wondering how to beat inflation? Thinking about getting a financial adviser? Well hate to break it to you, but you don’t need one until it is really necessary. This complete guide will help you over smart inflation and protect you from all those raising interest rates. The only way of beating inflation is to keep up with it, using our complete guide, “How to beat inflation.
1. What is Inflation?
To first learn, how to beat inflation, it is important to know what Inflation is. Inflation is the hike in the general price of goods and services in an economy, which results in a fall in the purchasing power of consumers. In contrast, the inverse of inflation is deflation, which occurs when prices of goods and services fall, increasing the earnings of the consumers.
Increasing prices are of course impacting our wallets, and credit card debt is increasing at the fastest rate in more than 20 years. Since 1900, the US Dollar has had an average annual inflation rate of about 3%, which is significantly lower than what we are seeing today. Ever since the war in Ukraine, the demand after the pandemic has increased. In addition to this, increased supply chain challenges have created the perfect storm for high inflation. The Federal Reserve has been raising interest rates and is likely to do so again, meaning the cost of variable-rate debt will continue to increase.
For Example: If you want to purchase a pen, that is ten dollars. You currently don’t have that much, so you decide to buy it later. A month later, you go to the same shop and get to know that its price is now eleven dollars. Your ten dollars haven’t changed, but their purchasing power has decreased. This situation is a classic example of inflation which you will cross almost daily in your life in a lot of products and services.
2. Types of Inflation:
Inflation primarily has three types: demand-pull inflation, cost-push inflation, and built-in inflation.
i. Demand-Pull Inflation
This inflation explains how increased demand for goods and services can cause prices to rise. People will generally pay more for something that is in short supply.
For Example, the price of traveling tickets is generally higher during vacation than the usual scenarios. So if you want to travel to your relative’s house during thanksgiving, you may have to pay fifty or a hundred dollars more.
ii. Cost-Push Inflation
When demand-pull Inflation is high, cost-push Inflation often kicks in. When the cost of raw materials rises for businesses, they must raise their prices regardless of demand.
For Example: If the cost of manufacturing a toy is usually five dollars, but because of cost pull Inflation, the price of raw materials is high—the manufacturing cost increases, and thus. You would have to pay more.
iii. Built-In Inflation
This inflation occurs when a company raises its employee’s wages or salaries to maintain profit margins by raising prices.
For Example, the wages or salaries of employees are increasing to keep up with the rising Inflation.
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3. Causes of Rising Inflation:
- Demand-pull Inflation
- Cost-push Inflation
- Built-In Inflation
- Regulations and Policies: Specific policies may also cause cost-push or demand-pull inflation. When the government provides tax breaks for certain products, it can boost demand. If demand outnumbers supply, prices may rise. Furthermore, stringent building codes and even rent stabilization policies may inadvertently raise costs and build an inflationary setting by passing those costs on to residents or artificially reducing the housing supply.
- Increased money supply: It is the total amount of money in circulation, which includes cash, coins, balances, and bank accounts. If the money supply overpowers the production rate, inflation may occur, particularly demand-pull inflation, because more potential purchasers will be there for that particularly limited supply. The Federal Reserve usually increases the money supply through a process known as Open Market Operations (OMO).
- Devaluation: Devaluation is the downward adjustment in a country’s exchange rate that results in lower currency values. A currency depreciation makes a country’s exports less expensive, encouraging foreign nations to purchase more devalued products. Devaluation also increases the price of foreign products in the devaluing country, encouraging citizens to prefer domestic products over imports.
4. Consumer Price Index:
The Consumer Price Index or CPI is an economic metric that records the overall change in consumer prices over time using a representative assortment of goods and services. CPI is the most renowned indicator of Inflation. It is calculated by the ‘Bureau of Labor Statistics” also known as BLS.
The BLS collects approximately 94,000 prices from about 23,000 retail and service establishments. However, both CPI indexes inferred from the data include the word “urban,” with the more wide-ranging and cited index covering 93% of the US population. The CPI consists of user fees and sales or excise taxes, but not income taxes or the investment’s prices like stocks, bonds, or life insurance policies.
The calculation of the CPI indexes from data considers substitution effects—consumers’ proclivity to shift spending away from products and categories that have become more expensive. It is also responsible for changes in product quality and features when calculating prices. The weighting of the CPI indexes’ product and service categories corresponds to recent consumer spending patterns derived from a separate survey.
The CPI for all the Urban Consumers, or CPI-U, represents 93% of the population in the United States who do not live in remote rural areas. It does not include spending by farm households, institutions, or military bases. CPI-U is the foundation for widely reported CPI numbers significant to financial markets.
The Consumer Price Index for Clerical Workers and Urban Wage Earners, or CPI-W, represents 29% of the population in the United States who live in households where income is primarily derived from clerical work or hourly wage jobs. The CPI-W index accounts for changes in the cost of living in Social Security payments and other federal benefits and pensions.
5. Problems with CPI:
i. Substitution Bias:
Prices for goods and services do not all change by the same amount from one year to the next. The number of specific items purchased by consumers varies according to the relative prices of things in the fixed basket. However, because the basket is specified, the CPI does not reflect consumer preferences for items that increase in price only slightly from year to year.
For Example, you go to purchase some fruits and notice that apples are five dollars and pears are seven dollars. Thus you decide to purchase more apples and fewer pears. It is the general consumer behavior where consumers tend to substitute low-cost items with higher-cost items, and the CPI does not account for this intuitive phenomenon.
ii. Introduction of New Items:
When new products are introduced, the value of a dollar rises because it can now purchase a broader range of goods. But as the CPI relies on a fixed consumer basket, it does not portray the dollar’s increased purchasing power which is equivalent to the reduction in prices.
For example, you decide to collect some new edition cards, and let’s say; you spend hundreds of dollars on them. This purchase would need to be included in an accurate estimate of the cost of living because you are spending your money on it. But since the CPI uses only a certain basket of goods, the introduction of a new product cannot be reflected. Instead, the new items, cards, are left out of the calculation.
iii. Unmeasured Quality Changes:
When the quality of an item in the fixed basket of goods used to calculate the CPI changes, the value, and desirability of the item change, as does the dollar’s value, even if the prices remain constant. Thus, without an actual price change, it is equivalent to a price reduction or increase.
For Example, your favorite pizza place sells your favorite pizza for ten dollars. But recently, they changed some procedures or ingredients, and the pizza is way more delicious, but they still sell it for ten dollars. Now, at the same price, your cost of living would remain the same while the standard of living would increase. This change would not be displayed in the CPI from one year to the next. While the Bureau of Labor Statistics attempts to correct this problem by adjusting the price of goods in the calculations, this remains a significant problem for the CPI.
Since now you are familiar with the terms, let’s find out how to beat inflation.
6. How to Beat inflation?
It is smart to invest in businesses with low capital needs, during inflationary times. They will be able to maintain your earnings. To ensure you stay ahead of inflation, you need to adjust your portfolio and investment strategies to the changing environment in the economy as well as the fluctuating stock market trends. You do have a lot of control over how high inflation will impact you, you just need to invest wisely.
Consumers can’t control inflation, but they can make money decisions that help to limit the negative repercussions of higher prices. In order to beat inflation, your total return has to be greater than the total increase in the cost of living. The following are ways you can over-smart inflation:
6.1. Invest in Growing Businesses that Require Low Capital
A great way to protect yourself from the negative effects of current and future inflation trends is to start investing in alternatives like fine wine, fitness centers, and many more. It is always a smarter idea to invest in a business with low capital needs, during inflationary times. They will be able to maintain your earnings during fluctuating times. Almost every time, investing involves risk but the risk depends on the type of business you invest in.
6.2. Invest in Your Talents
Investing in your talents is one of the best ways to beat inflation. Try bulking up your resume by learning a new skill through online resources or a local college. Though pursuing advanced degrees can be expensive, they can also help grow your knowledge base and make you an indispensable employee in the future. When you increase your value to your employer, then the customers that the employer provides can help you command your fair share of earnings. Earning extra cash, whether through a side hustle or promotion at work, will help balance out your wallet when paying for items that have gone up in price.
6.3. Consider TIPS- Treasury Inflation-Protected Securities
TIP or Treasury inflation-protected securities, are government bonds that help protect you from inflation. They are also designed to help you diversify your portfolio. “The principal of a TIPS increases with inflation and decreases with deflation, as calculated by the consumer price index,” the government clarifies. Basically, TIP pays investors a fixed interest rate twice a year, but the principal amount is adjusted with respect to inflation which is calculated by the Consumer Price Index.
6.4 Emergency Fund Is Vital
Though rates on savings accounts are low it is always a good idea to save up some money and open up a savings account. Past performance is no guarantee of future results, the value of your investment will fluctuate over time, and you may gain or lose money, hence emergency funds will always help in times of need. It is much better to earn some interest on your own savings than to get none.
6.5. Try Limiting Your Wants
There’s a very fine line between a need and a want. Simple money-saving strategies can help you beat inflation easily. Minimize ordering food from outside and try cooking at home more often. Buying in bulk for items you can store for a longer period of time can act as a huge money-saver strategy against rising prices. In addition to this, Revisiting your Insurance coverage could also unlock sizable savings.
6.6. Try Not to Panic About the Whole Situation
Yes, inflation rates are higher than ever but it is important that you don’t panic and take good and calculated financial decisions. Try cutting back on your wants and saving money whenever you can. Panicking will only make matters worse.
6.7. Holding Money in Cash Won’t Do Good
Diversify Your Investment Portfolio. Holding all of your money in cash won’t keep up with the 9% inflation rate we’re seeing. Branch out your Portfolio with Alternative Investments One of the most vulnerable asset classes in times of inflation is cash. For example, if you hold $500,000 in cash, considering an inflation rate of 8.5%, you’ll lose $42,500 in purchasing power.
6.8. Investing in Stocks Is a Much Better Idea Than Investing in Bonds
Commonly, Stocks Offer the Highest Average Annual Return of The Traditional Asset Classes Though They Are More Volatile, Followed by Bonds, and Short-Term Investments. However, Stock Prices Are More Fluctuating than Those of Other Securities. Government Bonds and Corporate Bonds Have More Moderate Short-Term Price Fluctuation than Stocks but Provide Lower Potential Long-Term Returns, Hence Involving Less Risk. Investing in The Asset Class that Can Beat Inflation Over the Long Term and Investing in Equities Through Mutual Funds Is the Best Way to Defeat Inflation.
6.9. Keep A Budget
Allocating a certain fund to a specific part of your life can help you save up tons of money. Many financial advisors suggest expending no more than 50% of your take-home pay on essential expenses like food and housing, which will allow you to give room to save for retirement, plan for short-term goals, and spend on non-essentials. Keep a close eye on your budget and you will be achieving your long terms goals easily. Spending less than you earn and avoiding high-interest debt can set a strong foundation for you as well as your children’s future.
7. Is Inflation Good or Bad?
While high inflation is generally considered harmful, on the other hand, a small amount of inflation is a sign of a healthy and growing economy as it can help drive economic growth.
“As long as you’re investing regularly, when inflation puts downward pressure on the market, you end up with more for your money in the long run.”
– Priya Malani, Founder, and CEO at Stash Wealth.
Whenever you invest your precious money always ensure that you determine goals and review your progress every so often. This way you can monitor and adjust whensoever necessary. This will allow you to change your investment strategy, elucidating whether you should save more money or invest more before it is too late.
Always look ahead and make sure you have one or more of these plans available to you to fight against inflation. If you are not sure about your saving strategies, then feel free to hire a personal financial adviser. Hope our guide, “How to Beat Inflation” proved to be an excellent companion for you. Happy Investing!
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