In 2021, Inflation is Real—but Don't Panic
The news has been carrying warnings from some big-name economists about a wave of growing inflation in 2021 and potentially beyond. But there's no need to panic.
Why? Well, for one thing, some inflation is always around in a healthy and growing economy. And even if it jumps a bit, what you will see is unlikely to even approach the higher inflation levels of the late 1970s and early '80s—chances are you know many people who lived through that—and there are ways to deal with it.
Inflation is pizza
Inflation is like ordering a slice of pizza. At least, that's how Mark Charnet, CEO of American Prosperity Group in Pompton Plains, N.J., explains it. "When I was seven years old, I would hop on my bicycle and ride to the pizzeria and order two slices and a coke," he says. "I paid with a dollar and got back change. The price today is $7.50."
Inflation means prices and wages go up. That happens all the time when companies see their costs rise or a lot of people buy goods or services when there aren't enough to go around. Or when people worry that prices will go up, and so they shop in response. Hopefully, wages and salaries rise equally.
But there's inflation...and then there's inflation. During the last 10 years, the rate has been barely noticeable to most people.
"Right now, it's hovering somewhere around 1.6 percent, 1.7 percent," says Emily Boothroyd, a partner and wealth manager at Merit Financial Advisors, headquartered in Atlanta. "We're still in a very low inflation environment." The Federal Reserve sees 2 percent as a normal level of inflation.
Inflation in the U.S. isn't always so gentle. In 1974, the rate hit 11.1 percent, and then 13.5 percent in 1980, according to the World Bank. That's a big annual increase in the cost of living—and exactly what some economists warn could return. There is also relative inflation; the average figure published by the government doesn't hit everyone and every place the same way. If you're about to put a child through college, the resulting bill incorporates historical 6 percent annual price increases, Boothroyd says. Compare it to your own educational experience and that might knock the wind out of your checking account.
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So even if there isn't a return to the inflation of the big-hair days, you can still get caught. Luckily, there are steps you can take.
Plan for inflation
The first step is to establish the right relationship to inflation. "Inflation is not a bad thing," explains Judith Lu, CEO of Blue Zone Wealth Advisors of Los Angeles. "It's growth that is necessary for us to recover from what has been very significant economic crisis."
When inflation is too low, you get an entirely different set of problems, like the zero or even negative interest rates that have already bruised finances in Europe and Japan. "You have to pay a bank to take your money and hold it for you," Lu added. "That concept is foreign in the U.S." At least so far.
Taking out the wildly high inflation expectations, the consensus view is 2.6 percent for 2021, according to Stephanie Richman, a regional director and partner for EP Wealth Advisors. "But in 2022, it's expected to go down a little bit to 2.3 percent and after that maybe closer to the Fed's target of 2 percent," she said. If right, inflation will be barely noticeable to many, if not most, people. Next, consider your personal inflation rate. College, looking for a new home, or major medical bills can drive it upwards.
As long as your expenses and your income increase at the same rate, you'll be fine in the short run. If, however, you spend more than you make, there are two choices for stability: Either lower your spending, or find ways to bring in more money—whether that's asking for a raise at work, or starting a side hustle.
Look at the future
Rising prices mean that your dollars are "losing purchasing power," says Sonia Mintun, managing director and portfolio manager at wealth management firm Ancora. While it does mean paying more for the things you buy, there is an upside: If you need to buy something and must borrow to do so (i.e., a mortgage), the dollars you put into fixed loan payments are worth less, so you get an effective discount.
"I wouldn't say go out tomorrow and buy everything you can, but if you're at a point where you need to buy something and you think the price will go up and that the rates will go up, now might be a good time to buy," Boothroyd says. Assuming you both need and can afford the purchase, that is.
Saving gets more complicated. When interest rates from banks or other investments are below inflation, holding cash means losing value. "The average money market rate today is 0.1 percent," Richman says. "If that's all you're earning in interest, but inflation is running at 1.7 percent, subtract that from 0.1 percent—you're earning a -1.6 percent."
Check with a financial planner, if you have one, to determine how to invest and be ready for those college bills, retirement, and any unexpected problems. You should have an emergency fund with anywhere from two to 12 months of cash. Even at moderate inflation, you will lose little over a period of a year or less. For example, $5,000 at 2.6 percent inflation over six months would lose only $130 in value.
And be realistic about the future. As prices rise, the money you'll need for college or retirement will grow significantly. Success will only come if you can "learn to live on less and to save more," Charnet says. "If you don't put it away, you're not going to have it."
