Savings tips for 2021
The U.S. is experiencing increasing pricing on many fronts, including gasoline, consumer goods, food, etc. (We are more accustomed to what seems like permanent inflation when it comes to healthcare and college education costs.) As a consumer, what is important for me to know about inflation? Does my financial behavior need to change? We checked in with Jenifer to get the answers.
What is important to know about inflation?
At its most basic level inflation reduces the value of one’s currency. If what cost me $1 last year, now costs me $1.10, my dollar is now worth less than it was a year ago. This is an important component to the value of investment securities. Since they at some point will likely generate income, if the value of a dollar today is going to decrease substantially because of inflation, that will decrease the value of that cash flow stream and therefore, the investment.
How does inflation impact a long term portfolio?
If you are focused on the long-term then not by much. If there is persistent inflation then interest rates will rise; as your investments generate income or mature you will reinvest at the higher interest rates which will adjust for inflation.
If inflation is on the rise, what should people expect to experience and for how long?
The current concern about inflation is whether it is ‘transitory’ or not. If it is transitory (which in other words means temporary) then once we transition to a normalized economic environment, inflation should go back to the general level (2-3%) it was before the pandemic. If it is more persistent inflation then we would see year-over-year inflation rates at higher levels than what we saw pre-pandemic and that could change the way we think about a lot of things. On one hand things we purchased would be more expensive but on the other hand we would likely begin to see interest on our savings and money market investments go up.
Should my financial behavior change?
Right now there is a lot of ‘frictional’ inflation as the economy and people re-adjust to the post-pandemic world. For example, used car prices have skyrocketed as people get back to living a normal life but don’t want to take public transportation. So more people are buying cars. If you don’t absolutely need to buy a new car over the next several months, don’t. Tip: if you have a lease coming due soon contact your dealer to see if you can extend your lease.
We know the Fed plays a role in combating inflation. What tools do they use and for how long?
The Fed’s long-term stated objective is to find a balance between unemployment and inflation. Their primary tool (though they have many) is to raise and lower the short-term interest rates they pay banks to hold their excess cash. With a long-term inflation target of 2% and a ‘full employment’ unemployment rate of 4% (the economy will always have some unemployment due to job changes and transitions), the Fed lowers interest rates if inflation gets too low and unemployment too high. It raises interest rates if inflation gets too high and unemployment too low. Higher interest rates will cool down the economy and (in theory) lower inflation. Lower interest rates will goose the economy and potentially increase inflation.
What else should we know?
Inflation is one of many factors that impacts the markets. It is important to remember that while the extremes of inflation/deflation can create a lot of market volatility, some inflation is good for the economy and ultimately good for our portfolios.
If you have more questions about inflation, please contact Jenifer@mosaicfi.com. We are always happy to take your questions.
Jenifer Aronson is the Founder of Mosaic Fi.