What Is Inflation Really?

Inflation, it’s the one thing that can make your paycheck feel smaller without changing the numbers. But what is it, really? Simply put, inflation occurs when prices go up and the purchasing power of your money goes down. This means the same $10 you use today to buy a sandwich won’t stretch as far tomorrow.

Inflation touches nearly every aspect of daily life, from the cost of groceries and gas to housing and utilities. Think about this for a moment, you’ve probably heard an elder in your family say, "I used to buy candy for a nickel." That’s inflation at work; back then, a nickel went a lot farther than it does now.

This blog will help you understand the causes of inflation, how it impacts your financial health, and, most importantly, how to protect yourself from its effects.

What Causes Inflation?

Several factors drive inflation, creating a ripple effect across the economy. Often, it’s a combination of these causes working together that makes prices climb.

Demand-Pull Inflation

When the demand for goods and services outpaces supply, prices go up, this is demand-pull inflation in action. Picture this: a farmer has 10 apples, and 15 people want to buy them. He can only sell to the highest bidders, so he raises the price. Now expand that scenario across the entire economy, post-pandemic spending is a great example. Many people returned to consumer habits armed with stimulus checks, creating heightened demand that existing supply couldn't meet.

Cost-Push Inflation

Here, rising production costs are to blame. Whether it’s due to higher raw material prices, increased labor costs, or supply chain disruptions, businesses pass these costs onto consumers. Think back to the early pandemic days when global supply chains were disrupted. Take higher oil costs as another example, when transportation costs rise, everything from food to manufactured goods sees a price hike.

Increased Money Supply

Ever heard the phrase, "too many dollars chasing too few goods"? When governments inject money into the economy (like stimulus checks), the increased cash flow can devalue the currency while driving inflation. While it's great to have extra money circulating, if supply can’t keep up, prices for goods skyrocket.

Currency Devaluation

A weaker currency often results in higher costs for imported goods. For instance, a dollar that loses value in exchange rates means costs go up for businesses (and consumers) relying on imported items. Whether it’s electronics or groceries, you’ll end up paying more.

How Inflation Impacts Your Financial Health

Inflation isn’t just numbers in the news, it hits your wallet in real life. Understanding its effects can help you prepare for its challenges.

Reduced Purchasing Power

If you’ve noticed your $100 doesn’t buy as much as it used to, you’ve experienced inflation firsthand. Over time, the real value of money shrinks as purchasing power declines. Imagine the difference between grocery costs today versus a decade ago. The numbers in your bank account may stay the same, but what you can buy with them decreases over time.

Higher Cost of Living

Inflation makes the basics, food, rent and utilities more expensive. The rise in essential goods and services can put immense pressure on household budgets. For instance, a gallon of milk that used to cost $2.50 now costs $4.00. Multiply this across your monthly purchases, and the impact adds up quickly.

Interest Rates and Loans

When inflation rises, central banks may increase interest rates to control it. This raises the cost of borrowing. Higher interest rates mean your mortgage, car loan, or credit cards become more expensive to manage. Did you know that inflation at 2% is ‘healthy’? However, inflation spikes like those during the 1980s (close to 14%) made basic loans and expenses nearly unbearable for many households.

How to Protect Yourself Against Inflation

Luckily, you don’t have to simply ride the waves of inflation, you can take actionable steps to safeguard your finances.

Budget Smarter

Start by tracking your expenses and cutting back where possible. Even small changes can add up in the long term. Use free budgeting tools, or even old-fashioned spreadsheets, to plan your spending. Prioritize your needs over your wants, cancel subscriptions you rarely use or dine out less frequently.

Invest to Beat Inflation

Investments can help your wealth grow faster than inflation. Over the long term, investment returns often outpace inflation rates. For instance, equities typically offer higher returns compared to inflation, although they come with risks. Explore stocks, index funds, or even energy-efficient upgrades to your home as practical solutions to protect against inflation’s bite.

Nerd Note: Investing $10,000 with a 10% annual return, a range roughly historical to stock performance, grows to $25,937 in 10 years, that beats most inflation spikes by a mile.

Look for Fixed Costs

One great way to adapt to inflation is by locking in fixed costs. For example, opt for fixed-rate mortgages to protect against rising interest rates or negotiate long-term rental agreements to avoid sudden rent hikes.

Diversify Income Streams

Multiple income streams can be a lifesaver during inflationary times. Consider adding a side hustle, selling unused items, or learning a valuable new skill to boost your career and income potential.

Inflation in Everyday Life

Inflation is all around us. For instance, the cost of eggs doubled in some areas between 2022 and 2023. Rising gas prices impact transportation costs and directly hit delivery services, leading to higher prices for just about everything.

Adjusting your habits can make a difference. Meal prepping can save you money on groceries. Shopping second-hand or during sales decreases your overall costs. Community sharing initiatives, like carpooling, can lower transportation expenses.

Understanding the Impact of Inflation on Debt and Assets

Inflation has a dual effect on your financial landscape, influencing both your debt and your assets. On the one hand, inflation can help decrease the future costs of your debt by decreasing the value of those payments over time. This means that as inflation occurs, the money you owe becomes relatively less burdensome in real terms. However, it's important to note that inflation can also erode the value of your assets.

As you accumulate wealth, the value of your ability to purchase items will decrease if your asset growth doesn't keep up with inflation. Therefore, it becomes crucial to ensure that your investments and savings are growing at a rate that outpaces inflation to preserve the purchasing power of your assets over time. Understanding this dynamic can help you make informed financial decisions and take proactive measures to protect your long-term financial well-being in the face of inflation.

Looking Ahead - What You Can Do Today

It’s easy to feel overwhelmed, but staying proactive can empower you to fight inflation. Here are immediate actions you can take today:

• Review your expenses over the last year and determine where you are getting your value and where you can save more to build more flexibility in your budget cash flow
• Ensure that any cash you have over a few months of expenses is in an account that is yielding a higher amount, high yield savings accounts like Ally, Marcus, or Betterment offer competitive and good user experience consistently
• Reconsider paying down debts that are less than 5%, since in "real" post inflation terms, they are not costing you as much as you may think

By following good financial habits and staying alert, you can reduce the silent stress inflation adds to your financial life.

Taking Control in an Inflationary World

Inflation impacts everyone; it’s unavoidable. But the good news? You can take control of how it affects you. Developing sound financial habits, budgeting, investing wisely, and adapting to changes, can mitigate inflation’s impact and even help you thrive during challenging economic times.

At HealthyFP, we’re here to help you every step of the way. Want expert guidance to build your resilience against inflation? Connect with us today and start planning smarter for a more secure, stress-free financial future.