What individuals can do to combat the effects of inflation

Inflation is a decline in purchasing power over time. Low rates of inflation tend to signal a healthy economy, but when inflation accelerates sharply, it can have a major impact on your financial situation.

What causes inflation?

Inflation occurs when demand outstrips supply. Sometimes this happens in a hot economy when consumers are spending freely and buying up the supply of a certain product, causing its price to rise.

Other times the imbalance occurs due to circumstances that create supply chain delays and eat away at a product’s availability, as has happened throughout the COVID-19 pandemic. Either way, the result is inflation.

What are the effects of inflation?

In general, inflation causes the price of many goods and services — from a slice of pizza to a hotel reservation — to go up.

Not every industry is affected by inflation equally. In the current economic landscape, consumers are especially likely to encounter higher prices at the car dealership and the grocery store.¹ In the fall of 2021, the average price of a new car hit an all-time high of $45,000,² and the prices of meat, fish, poultry and eggs rose 12.8% from January 2021 to January 2022.

These sharp increases can be a problem because most people’s income hasn’t kept pace. In fact, according to our recent research, Americans say the top barriers to strong financial health are not getting paid enough and constantly increasing expenses.

Three tips for protecting against inflation

Inflation is an economy-wide phenomenon, so individuals can’t prevent or stop it. But if you organize your spending and investments wisely, the following steps can act as a hedge against inflation.

1. Save, then spend wisely

The first step in combating inflation is to assess your current financial situation and revisit your budget. Whereas you might not be able to avoid costs associated with basic needs, you can look for ways to curb your discretionary spending. What were you hoping to buy that can wait until prices stabilize?

At the same time, interest rates are historically low right now. Are there any big purchases you can make that will take advantage of low interest rates before they rise?

If you’ve been thinking about buying a new house, there are many factors to consider. What’s your ability to afford a mortgage now, as opposed to when interest rates rise? The value of real estate tends to appreciate over time, so if the recent sharp increase in home prices doesn’t deter you, now might be the right time to act.

2. Refinance and renegotiate

Now is a good time to revisit your existing debt and interest rates.

Focus first on debt that has adjustable or variable rates. For example, an adjustable-rate mortgage (ARM) fluctuates as interest rates change once the fixed rate period ends. The rates on ARMs rise when interest rates rise — as they often do during periods of inflation, so it may make sense to lock in a fixed rate instead.

When you have a fixed-rate mortgage, you pay the same amount each month through the loan’s lifespan, regardless of the rate of inflation. In other words, lenders cannot raise the interest rate on your mortgage to make up for rising overall interest rates. If you already have a fixed-rate loan, maybe you can refinance your mortgage and get a better rate.

Check in on your credit card payments, too. Do some research and identify a few credit cards with lower APRs than your current cards offer. Then connect with your card’s customer service department and see if you can negotiate a better rate. They might offer you a lower rate right away.

3. Invest carefully

It’s important to remember that sharp increases in inflation are typically temporary, but it’s difficult to know when rates will normalize. You don't necessarily need to search for specific inflation investments, because a diversified portfolio should be able to withstand periods of rising prices. A healthy mix of stocks and bonds may be one of the best ways to reach your savings goals.

That said, if you have some extra money lying around, consider investing it to hedge against inflation. That way your money may not lose value, as it might if you kept it in cash or a savings account. Keep in mind that stocks are the only major asset type that has historically outpaced inflation over the long run.³

If you’re looking to invest in market sectors that perform well during inflationary periods, value stocks or companies that sell essential goods have proven pricing power, meaning generally they may be able to increase the prices of their products without scaring off customers. Keep in mind however, investing involves risk, and just because an investment does well in the past, doesn’t necessarily mean it will continue to do well.

While inflation tends to worry people — it doesn’t have to spell trouble. With a little patience and planning, you can adjust for rising costs, and if you save and invest wisely, you may even come out on top.