As a little kid I can remember my grandparents reminiscing about the good old days and how much things used to cost. A pack of candy used to cost a nickel. A new car was a couple thousand dollars and they actually purchased their house for under $20,000.
Even as a little kid, I was always amazed at some of their stories. Probably more so about the candy than the price of a house. Now of course I’m more amazed at the house part.
What they were talking about that I didn’t understand at the time was inflation. From 1913-2020, average yearly inflation was 3.10 percent according to this report from Inflationdata.com.
3.10 percent may not seem like much year after year, but over time it’s significant, and can erode your wealth. Especially for those on a fixed income. And remember, 3.10 percent is just the average over a one hundred-year plus timespan. There have been decades where inflation was much lower, and other decades where it was much higher than the average.
Economists have differing opinions on where inflation is headed; some say we are going to have more inflation, others say we’re not. The arguments are valid on both sides, and the reality is that nobody knows for certain. Looking at the historical data since 1913, I don’t think it’s unreasonable to think that inflation will continue to occur.
Either way, it’s good to prepare for as many likely scenarios as possible and abide by sound financial principles. Of course we can’t prepare or protect from every scenario, but we can all do what’s reasonable. Here are five ways I try to control the impact of inflation.
1). Make the Biggest Part of Your Housing a Fixed Cost
One of the biggest monthly costs for the average person is housing. The good news is that we have some control in this area by making it a fixed cost. By purchasing a home, we can make our combined principal and interest payments a fixed cost. When I refer to a “home” I’m referring to any type of dwelling—house, condo, townhome, manufactured home, etc.
If our principal and interest payments were $1,800 when we purchased the home 15 years ago, those payments will remain the same assuming it was bought with a conventional loan. And it will remain the same throughout the life of the loan. Even if your house triples or quadruples in value over that time period, your principal and interest payments will stay the same unless you refinance.
Contrast that to renting. Most property owners, whether they are big companies, or “mom and pop” landlords, routinely raise rents. As expenses and the market value of rentals goes up, the rent increases. The costs just aren’t itemized (insurance, property taxes, maintenance, etc.) like they are for homeowners. So renters are impacted by inflation, it’s just in a different way than homeowners.
Although principal and interest is a fixed cost for homeowners, there are monthly expenses that increase. So it’s not a perfect solution. Some states routinely enact large property tax hikes, others limit the yearly amount. Insurance costs also vary wildly across the country, with many of the costs depending on weather and fire issues. Those can both be very large expenses.
Then of course there’s electric, water, trash and sewer, and maintenance. All those costs other than maintenance have to be paid whether you own or rent, so they basically cancel out when deciding whether to rent or buy.
Even with some of these price increases, principal and interest remains a fixed cost, which is a massive victory for the homeowner. It’s basically a shield from rising home costs. You may be paying $1,800 a month principal and interest to live in your neighborhood while your neighbor who just moved in a year ago is paying $4,200 per month in principal and interest. Huge difference.
Not to mention that eventually your fixed principal and interest cost will go away after your loan is paid off. Then it becomes better than a fixed cost, it becomes a “no cost.” That of course adds more money to your monthly income stream. The reduction or elimination of a debt is just like a pay increase.
2). Reduce the Frequency of Big Ticket Items
With inflation, it’s already established that goods and services increase in price over time. This is especially noticeable in big ticket items since they are already expensive to begin with. Add inflation to already high costs and they seem to increase even more drastically.
There’s a fairly obvious point I want to make. If you’re not purchasing a big ticket item to begin with, you’re not impacted by the price increase at all. For example, if a new boat cost 20,000 dollars ten years ago and now costs 25,000 dollars that’s an increase of $5,000. However, if you don’t buy the boat, it doesn’t matter how much it went up in cost.
The price of a new boat could quadruple in price from ten years ago, and it wouldn’t matter if you’re not buying it. That’s one of the reasons I write so much about value-based spending. Value-based spenders know exactly what they want, and don’t want. They also understand the difference between a necessity and want.
Value-based spenders are inherently protected against large purchases not important to them, or that are not a necessity. Other examples of big ticket items:
- RV
- Jet ski
- Third of fourth car
- Very expensive vacation
- Swimming pool
- House remodels
This section is not about depriving yourself or your family. It’s to make you aware of ways to combat inflation by avoiding big ticket items you don’t need or value. If you and your family really enjoy traveling around in an RV, use it frequently, and pay for it in cash, then it’s probably worth purchasing. But if you’re just going to use it a week or two out of the year it’s probably not worth it.
3). Keep Your Car Longer
Cars are expensive and are one of the most common big ticket items, so they get a category of their own. Just like with other big ticket items, a car is going to cost more than it did five or ten years ago due to inflation.
The longer you keep your car, the less impacted you’ll be by price increases due to inflation. If you’re not buying a car, you’re not impacted by the increased prices.
Imagine someone who purchases a new or used car every five years. They are impacted by inflation in the purchase price every five years. Contrast that to someone who purchases a car every ten years. That person is only impacted by inflation in the purchase cost every ten years.
Most cars are built to last many years as long as they are properly maintained. It’s not a necessity to purchase a new vehicle every few years, and keeping your car longer will reduce the impact of inflation on your monthly finances. Assess whether this is an expense you want to incur less frequently.
4). Reduce Unnecessary Costs
Just like with big ticket items, the unnecessary purchase of anything you don’t highly value or need, will make you more susceptible to inflation. Even consistent small purchases can make a big difference.
If a cup of coffee and snack used to cost $5 ten years ago, that would come out to $25 a week assuming you purchased every weekday morning. If that same cup of coffee and snack now costs $7, that’s $35 per week. Or in other words, $10 a week, $520 a year more.
If you really value ordering out the coffee and snack, keep buying it. But if you don’t, that’s an immediate way to reduce the impact of inflation. If it used to cost 75 cents a day to make your coffee and snack at home, and now costs a dollar, that’s a difference of 25 cents. $1.25 per week and $65 for the year. That’s a big reduction from $520.
It’s impossible to completely beat the inflation cost of goods—you’re still paying $65 more yearly for the coffee and snack, but that’s much better than the $520 per year extra you’d be paying by ordering out.
Think about purchases like TV’s, computers, dishwashers, washer and dryers, ovens, and other common household items. The less you purchase them, the less you’re impacted by inflation.
If your dishwasher works fine and is only five or six years old, you probably don’t need a new one. If it’s not high on your value list, that’s a cost you can push several years down the line until you need a new one. Same for the other common household items.
5). Invest
The last way to beat inflation on this list is by investing. The math is fairly simple. As long as your investments are averaging higher returns than the rate of inflation, you are minimizing or beating inflation. There may be time periods where investments underperform inflation, but investing is a long game.
If inflation over a 20-year period is a little over three percent, and your investments earned around 10 percent during that time period, the invested money is beating inflation by about seven percent. Even if your investments are earning a smaller amount like five percent, you’re still beating inflation. Where inflation really erodes wealth is when people park large sums of money in a low yield savings account.
You may have heard the phrase “investing is risky.” Which is true, there is a certain amount of risk in investing. It’s possible to lose money, especially when an investor mistakes speculation for investing. What you don’t hear as much though, is that not investing is also risky.
If someone keeps large sums of money in a low yield savings account for many years, their wealth is almost guaranteed to be eroded by inflation. For example, if Person A puts $100,000 into a low yield savings account earning one percent for ten years, they are losing a little over two percent (assuming inflation is approximately three percent) of their money to inflation over that time period. It’s hard for your money to grow if it’s underperforming inflation.
On the other hand, if Person B puts $100,000 in an investment earning seven percent, that money is beating inflation by four percent. Even at the modest return of seven percent.
The one exception is with an emergency fund. An emergency fund is designed to be a safe place to keep your money in case something goes wrong like a job loss, or a large unexpected expense. It’s kind of a tradeoff—you put three to nine months of cash in a savings account and it’s there if you need it. It’s going to lose money to inflation but it’s money that’s there just in case.
In Closing
Inflation is very real and will erode your wealth if you allow it to. Fortunately, there are actions you can take to beat or minimize inflation. Implementing even a couple of these strategies will put you ahead of the game. Implementing all of them will put you way ahead.
