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Inflation can impact your wallet, behavior

Why all the recent fuss about inflation? What does it really mean for you personally?

Academically speaking, inflation is defined in such terms as Consumer Price Index (CPI), Producer Price Index (PPI), Personal Consumption Expenditure (PCE) Price Index, Core Inflation … and the list goes on.

But as an individual, you play many roles that are affected by inflation. You are a consumer of goods and services, a saver, an investor, and, possibly, a wage earner, so it’s helpful to discuss inflation in terms of what it means to your own household and lifestyle.

Just as a balloon goes up when it gets inflated, so do prices when there is inflation. You pay more now to buy the same things that cost you less in the past.

For example, if you buy bread, milk, eggs and clothes that cost you $100 last year, but it now costs you $110, that extra $10 is because of inflation. Inflation means the prices of things are going up over time, so your money doesn’t buy as much as it used to. The value of your money shrinks, which is called reduced purchasing power.

During periods of inflation, you often prioritize essential goods and services (such as food, housing and health care) over discretionary purchases (such as entertainment, vacations or luxury goods). Inflation naturally causes you to become more price-conscious.

To help cope with higher prices, you may buy more things on sale, use coupons, cut back on nonessential purchases or look for cheaper alternatives, such as cheaper brands over preferred brands. Changes to your consumer spending patterns are based on factors such as income level, personal preferences and economic conditions.

Inflation can erode the real value of your savings and/or investment portfolio. If the rate of inflation is higher than the interest earned on savings, you’ll experience reduced purchasing power on your savings over time.

As an investor, if your investment portfolio fails to outpace inflation, your real returns are reduced, also reducing the purchasing power of your investment portfolio over time. Depending on willingness to accept investment risk, investors often react to inflation by adjusting portfolios to include assets that have historically performed well during inflationary periods and by hedging against the erosion of purchasing power caused by rising prices.

Inflation influences your borrowing behavior too. Many homeowners currently enjoy a fixed-rate mortgage that is well below what is now available to new borrowers. This means fewer homeowners are willing to sell, leading to lower housing inventory.

Additionally, many new borrowers are not willing to assume debt at elevated rates over those offered in more recent years past, so inflation can impact the number of people enjoying new homeownership.

As a wage earner, if your wages do not keep pace with inflation, your purchasing power declines in terms of real income, thereby making it harder to afford goods and services.

This can become a Catch-22 situation, whereas a push for higher wages causes the company to experience increased labor costs, leading to a price increase by the firm that further contributes to inflationary pressures in the economy.

High inflation rates can create uncertainty as you struggle to predict future prices and plan your household budget, leading to financial stress and instability.

It can pose challenges for saving and investing, which ultimately affect your financial well-being over the long-term. It can impact your real, inflation-adjusted earnings and related purchasing power of your wages.

Because purchase power erosion caused by inflation can effectively take your money without offering something in exchange, renowned economist Milton Friedman stated, “Inflation is taxation without legislation.”

Inflation has significant implications for government, businesses and for you, as an individual. Pay attention, adjust as necessary and always keep an eye on the future.

Wendy Bennett is a senior financial adviser at Bennett Associates Wealth Management in Butler.

Bennett Associates is a registered investment adviser and does not provide any legal, accounting or tax advice. The material prepared is the opinion of the author and for informational purposes.

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