Inflation is getting a lot of attention in the news lately, and if you’re wondering how it affects your long-term financial plan, you’ve come to the right place. In this blog, we’re discussing what inflation means for the economy and for you as an individual, as well as how you can maintain your purchasing power when inflation is on the rise. 

Back to Basics

At its core, inflation is an increase in the cost of goods and services over time. As inflation rises, the value of your dollar decreases. In everyday life, that looks something like this: if you have $100 and buy a basket of groceries in October, then in November that same basket of groceries costs $105, your $100 can no longer purchase that same basket of groceries—all because of inflation. (Wondering what that looks like for your Thanksgiving meal? Check out this article about how recent price increases could affect your turkey dinner.) 

When it comes to your retirement plan, inflation is one of the main reasons you invest cash rather than preserve it all in a savings account—you need the value of your dollar to keep pace with the rising cost of goods. When you leave your money in an account that earns anything lower than the rate of inflation (as most savings accounts do), you lose money—or at least, the purchasing power of your money.

Inflation: good or bad?

That doesn’t mean inflation is bad, though. In fact, steady, predictable inflation is good for the economy—it signals growth and healthy demand. When demand increases, businesses generate more goods and services to keep up with the demand, which means they need to hire more people, which means more jobs are created and wages increase, which means there are more people working and earning money. And when people make more money, they generally buy more, which makes the cycle repeat and leads to more growth. All in all—a good thing.

Stagflation, on the other hand, is when inflation rises and economic growth (you guessed it) remains stagnant. In this scenario, your dollar gradually loses purchasing power without the positive benefits that come with inflation.

On the far end of the spectrum is deflation, when prices decline over time. This isn’t healthy for the economy either, since it usually means companies must limit production to remain profitable, which leads to lay-offs, which leads to decreased spending, which leads to less profit… and you see the problem. 

So, all in all, steady inflation is a good thing—so long as it doesn’t get out of control.

What should I do with my money when inflation is on the rise?

If the inflation rate is 2.5 or even 4 percent like it’s been the past few months, keeping cash in a standard savings account that earns (at most) 0.5 percent means you’re losing purchasing power over time (assuming the inflation rate remains steady). In this case, you have a few options:

• Keep your money in a savings account, where you’re guaranteed to maintain the same amount of cash but lose significant purchasing power.
• Invest in the asset classes like the stock market where, historically, returns outpace inflation^[1] but the risk of losing money is much greater.
• Purchase bonds, which generally have a higher rate of return than a savings account, but may not keep pace with high inflation.

When it comes to planning for retirement, a goals-based plan is a great way to preserve your purchasing power without risking everything in the stock market. Here’s what that looks like in practice: 

1. Determine how much cash you’ll need to maintain your lifestyle for the next 12 months or so and keep that amount in a traditional savings or checking account. You might “lose” money as inflation increases, but you’ll have the cash available to spend when you need it.
2. Then, calculate what you need for the next three to five years and invest that in bonds—again, you might lose some purchasing power in the short term, but you’ll gain a little interest without placing high risk on cash that you’ll need soon.
3. Then, once you’ve accounted for your short-term needs, invest the rest in growth-oriented assets like stocks that have the potential to outpace inflation during the next 10 to 30 years of your retirement.

The Bottom Line

There’s no one-size-fits-all investment strategy—the important thing is to know what your needs are and adjust your cashflow accordingly. When it comes to inflation and your retirement plan, there are two things you don’t want to do: hoard cash in a savings account and lose significant purchasing power over time; and invest money in the stock market you can’t afford to lose because you’re afraid of losing purchasing power.

It’s about balance.

If you need help determining what that looks like for you, just let us know—you can schedule a call with one of our advisors here.

[1]Past performance is not indicative of future returns.