How to Beat Inflation

Prices are climbing at a rate we have not witnessed in four decades. It’s hard to avoid panicking when your paycheck is unchanged, but food, gas, and other prices are higher every time you take out your wallet. However, you can beat inflation in 2022 with smart spending, saving, and investing strategies. Here’s how.

What Is Inflation?

The inflation rate is the speed at which prices for goods and services increase. Inflation degrades the value of your savings and reduces your purchasing power. 

How do we calculate inflation? The Consumer Price Index (CPI) is the most widely used measure of the inflation rate. The US Bureau of Labor Statistics (BLS) measures price changes faced by urban consumers, who represent 93% of the U.S. population. It analyzes the prices of 80,000 items and services including gasoline, groceries, medical appointments, and entertainment.  The Consumer Expenditures Survey determines what Americans buy and how much we purchase. Prices are weighted according to how important it is to the average American. For instance, we spend more on chicken than tofu, so changes in the price of chicken impact the CPI more.

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How Does Inflation Affect Debt?

Inflation makes new borrowing more costly because it drives interest rates higher. But how does the inflation rate affect debt that you already have? 

It depends. If you have loans with variable interest rates, like most home equity lines of credit (HELOCs), the interest rate on your balance (and your payment) is likely to increase. Ditto for adjustable rate mortgages (ARMs). Fortunately, you’re probably protected from a sudden, unaffordable spike by interest rate ceilings. 

Ceilings restrict the interest rate on variable rate loans in two ways – a lifetime rate cap and an adjustment cap. The adjustment cap limits how high an interest rate can go during a specific adjustment period. A 2% limit for an annual adjustment is common. And a lifetime cap sets the maximum rate of a loan. One common limit is 6% over the loan’s start rate. 

What about credit cards? Does the CARD Act protect consumers from spiking interest rates on balances? Arbitrary credit rate increases apply to new purchases only and you must get 45 days notice before they take effect. But rates charged on existing balances can rise any time when the change is due to a variable indexed interest rate. And almost all credit cards have variable indexed interest rates. 

As the Federal Reserve raises short-term interest rates, rates for any product tied to a financial index like the Prime Rate will also rise. And credit card issuers do not need to provide notice of these increases. 

On the other hand, if you have a mortgage, auto loan, student loan, personal loan, home equity loan or line of credit with a fixed interest rate, your interest rate and payment won’t rise. You’ll be protected from inflation.

How to Beat Inflation When You Have Debt

If you have a lot of debt with variable interest rates, list them and prioritize them in order of damage potential (high variable-interest rate accounts should take precedence over lower variable-rate or fixed-rate accounts). If you have variable rate loans with an option to fix the interest rate and can’t pay off the balance quickly, consider converting them – even if the new rate is higher. 

Try to pay off as much high-interest or variable rate debt as possible. The two most popular strategies for debt acceleration are the debt avalanche and debt snowball methods. 

If you can’t accelerate debt repayment, consider refinancing variable-rate accounts into fixed-rate loans. For example, you could pay off credit card balances with a fixed-rate personal loan and stop worrying about interest rate increases. 

Another option is a fixed home equity loan. And if you have excellent credit and income, you may still qualify for a zero-interest balance transfer credit card. Now is the time to apply because they might not be available if inflation continues to increase. 

Note that refinancing high-interest debt is only smart if you control your spending and refrain from carrying credit card balances. 

What if you’re in serious trouble with debt and your credit card rates increase? Try contacting a credit counselor who can put you into a debt management plan (DMP). Credit card companies are often willing to work with credit counselors and lower your interest rates to keep you from defaulting on your accounts. 

Another option when rising interest rates make payments unaffordable is debt settlement. Debt settlement means negotiating a lower payoff for your unsecured accounts (like credit cards). Creditors are not obligated to allow this but many will if you demonstrate that you can’t afford the payments. 

How to Beat Inflation With Savings

Every month that the inflation rate exceeds the rate on your savings causes you to lose money. And interest rates on savings accounts have been near zero for years. It’s time to re-evaluate your investments if you don’t want to continue to lose purchasing power. 

Currently, even so-called “high yield” savings accounts are paying less than 1%, while the inflation rate as of this writing is 8.3%. So you can see that money in a conservative account is hardly safe – right now, those accounts are guaranteed losers. 

Here are some better tips for bolstering your savings during inflation:

• Don’t keep too much of your money in cash (or a low-interest checking or savings account). Your emergency savings should be accessible, but the rest of your savings can be invested more aggressively. 

• Consider Treasury Inflation-Protected Securities (TIPS), which are government bonds that help protect you from inflation. They are currently paying 9.62%.

• Don’t lose focus. Inflation can encourage spending and discourage savings. But it’s a bad idea to spend unnecessarily and a really bad idea if you finance your purchases. Even at a low interest rate, saving will still be better for your future than spending. 

• Continue to contribute (or even increase contributions) to your company 401(k). Make sure you take full advantage of any matching funds. 

Inflation can be nerve-wracking, especially if you’re nearing retirement or on a fixed income. You can combat inflation in retirement by being a little less conservative in your investments, but don’t risk it all if you don’t have time to earn it back. 

How to Beat Inflation With Budgeting

Americans are being pinched every day by food inflation, rising gas prices, and supply chain problems. One no-brainer way to combat inflation in 2022 is to reduce what you spend, at least temporarily. Here are a few ideas that anyone can try.

• Create or update your budget. If prices across the board increase by 8%, look for ways to cut total spending by at least 8%. 

• See what car-pooling or public transportation can do for your gas expense. If you have more than one car, consider selling a vehicle for extra money, to eliminate an auto loan payment, and to cut insurance costs.

• Examine what you spend on food and look for cheaper alternatives – try discount stores or less-processed food options (which are healthier anyway). 

• Try packing your lunch two or three days a week instead of going out to lunch. 

• Get together with friends for pot luck instead of routinely eating out. 

• Consider canceling your gym membership and getting a group together for a run or yoga workout. 

• Let your hair grow a little between cuts. Ditto for regular maintenance like facials or massages. If you normally go every four weeks, make it every five weeks. That’s a 20% reduction in costs. 

• Hit your friends up again and exchange babysitting or pet sitting for less-expensive nights out or weekends away. 

• Shop your big-ticket expenses like insurance. See if you can drop costs by raising your deductible or finding a lower-cost provider. 

• Make friends with your town – local parks, the library, walking trails, museums, and other low-cost venues. 

You may pick up some good habits over the next few months. That will position you to save more and make up extra ground once inflation is under control and prices come down.

How to Invest to Beat Inflation

It’s unfortunate that when the inflation rate is high, so-called “safe” investments become sure losers. Here are some alternatives.

Investments like bonds, stocks, and mutual funds historically perform much better than savings accounts. However, with higher returns comes greater risk. One way of minimizing risk is by diversifying your portfolio. For instance, bonds tend to perform better when stocks are losing. So you can protect yourself from stock losses to a certain extent by investing in bonds as well as stocks. 

There are many ways to diversify your investments, and the right formula for you depends on your age, financial circumstances, and tolerance for risk. One way to diversify is to simply purchase shares in an indexed mutual fund. It keeps management costs low and you don’t have to worry about picking individual stocks. Another alternative is robo-investing, a brokerage account that automatically allocates your investments according to your financial position and goals. 

One investment favored by pros (including Warren Buffet) for combating inflation is rental real estate. When inflation takes hold, rents rise. And if you finance your property with a fixed-rate mortgage, your payment won’t increase when your rental income goes up. 

Invest in Yourself to Beat Inflation

One investment that can help you beat inflation and improve your finances in the future is the investment that you make in yourself – into your skills or into a business. 

Warren Buffet explained this in 2009: “If you’re the best teacher, if you’re the best surgeon, if you’re the best lawyer, you will get your share of the national economic pie regardless of the value of whatever the currency may be,” he said. 

Buffet said that you can achieve success as a skilled employee or businessperson: “The second best protection is a wonderful business,” he explained, which means a company that has good demand for its products even if it has to raise prices. 

Buffet doesn’t recommend businesses that require a lot of capital to start or run because inflation increases the cost of borrowing. But anyone can start a side gig with little upfront funding. And if you’re very good at what you do, that little business could grow into a profitable, inflation-resistant source of income. 

Beating Inflation at Home: Don’t Panic

While the May 2022 annualized inflation rate was a jarring 8.6%, many analysts believe that the worst might be behind us. And by restricting our spending, accelerating debt reduction, and investing wisely, we can emerge in a stronger financial position than before.