How Inflation Affects Your Finances and How to Stay Ahead

Many people were caught off guard when inflation surged in 2021 and 2022. And though things have cooled substantially since then, the impact was (and still is) painful for some.

It’s hard to prepare for such a significant surge in prices across such a wide spectrum — from gas and groceries to utilities and housing costs. (And, let’s face it, we had gotten used to the inflation rate hovering around 2% for several years before it spiked to 9.1% in June 2022.)

But the reality is inflation should always be a factor when it comes to planning your finances.

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Even when inflation is low, you can expect the cost of goods and services to rise over time and affect your purchasing power.

This is why it’s essential to have a financial plan that helps you keep pace with inflation — whether you’re a young professional working and saving for your future or a retiree trying to get the most from your savings.

Here’s a look at how inflation can affect both your pocketbook and your portfolio, along with practical strategies to help you stay financially resilient.

Erosion of purchasing power

One of the most immediate effects of inflation is the reduction of purchasing power. As prices rise, the same amount of money buys less. That can put a financial strain on just about everyone, especially low- or moderate-income workers and retirees on a fixed income.

Both younger workers as well as retirees and soon-to-be retirees can benefit from thoughtful budgeting, cutting out unnecessary expenses and carefully weighing their priorities before making major purchases.

Younger workers may also want to focus on increasing their earning potential through skill development, career growth and strategic investing.

Impact on investments and savings

Inflation can erode the real value of savings, which makes it crucial to invest in assets that have the potential to outpace rising prices. Market volatility can make “safe” investments (CDs, savings accounts, etc.) seem more appealing to investors of all ages.

But you may actually be losing money if those investments can’t keep up with inflation. A carefully planned portfolio mix that aligns with your time horizon and risk tolerance can help you stay secure while also earning enough to combat rising costs.

For example, investing in diversified and long-term growth assets, including equities and real estate, can help younger workers grow their money for the future.

Signing up for your workplace retirement plan also is an easy way to make investing automatic — and you can take advantage of your employer’s matching contributions to accelerate your savings.

Contributing or converting to a Roth IRA can also be a smart way to mitigate both tax and inflation risk in retirement.

Meanwhile, retirees and soon-to-be-retirees should consider a diversified portfolio that might include dividend-paying stocks, Treasury inflation-protected securities (TIPS) and other income-generating assets designed to keep pace with inflation.

Effects on the broader economy

Although the effects of inflation may feel very personal when you’re paying for your groceries or checking your bank balance, inflation also influences the economy as a whole.

When inflation rises, central banks often respond by increasing interest rates to slow down excessive price growth. Higher interest rates can make borrowing more expensive for businesses and individuals.

This is why, when possible, younger workers should comparison-shop for the best loan offers and lock in lower interest rates. This can help with the cost of buying a home or car or starting and growing a business. Keeping your credit in good standing can help you score the lowest rates.

Retirees and soon-to-be retirees should build a balanced portfolio that can withstand changes in interest rates and inflation. A financial professional can help stress-test your portfolio to determine if you’re prepared for retirement risks like market volatility and inflation.

Dealing with debt in an inflationary environment

While inflation increases the cost of goods and services, it can also reduce the burden of certain types of long-term debt. Those with fixed-rate mortgages and student loans may benefit, for example, but retirees need to be cautious about taking on new debt.

Younger workers with too much debt may want to prioritize paying off high-interest credit card debt while maximizing the long-term benefits of low-interest, fixed-rate loans.

Retirees and soon-to-be retirees can also benefit from managing their expenses and keeping credit card balances low, as well as avoiding excessive borrowing that could strain their retirement income.

Inflation-proofing your plan for the long haul

Investing and saving wisely, managing debt strategically and building a reliable income stream you can live on now and in the future can help ensure long-term financial security.

If you don’t know where to start, a financial adviser can assist you with creating or assessing your overall financial plan. They can also help you identify and implement appropriate inflation-fighting strategies.

Inflation is a natural part of the economic cycle, but it doesn’t have to derail your financial goals. By taking proactive steps to mitigate its effects, both retirees and those who are still working to build their wealth can navigate inflationary periods with confidence.

Kim Franke-Folstad contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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