How Inflation Impacts Finances: Minimizing its Impact
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Even if you haven’t been reading about the inflation rate and what various economists think about the direction inflation is heading, it’s almost impossible that you haven’t felt the impact of inflation in the past year or two.
Higher interest rates (with some supply chain shortages) have caused higher prices in various areas, with consumers and their purchasing power taking the biggest hit. This makes everyone’s cost of living shift, tracked, in part, by the consumer price index, which charted an annual gain in common goods and services of 6.4%.
When it comes to financial planning, the effects of inflation can wreak havoc on your financial goals. However, just because inflation remains high doesn’t mean you must roll over and give up. Keep reading to learn more about how inflation impacts your personal finances and what you can do to control and minimize how it negatively affects your day-to-day life.
In this article
How inflation affects your personal finances
Inflation manifests in two significant ways that can hurt your personal finances if you aren’t smart about things. To start, inflation generally causes higher interest rates as the Federal Reserve raises rates to try and combat inflation. That means that if you have credit cards with variable interest rates, you will pay more in interest while your cards carry a balance. The same is true for other kinds of loans that don’t have a fixed rate.
The other big way that inflation impacts your personal finances has to do with price increases. When the price of goods is higher, your buying power goes down. This is relatively simple to understand; however, the impact is often more detrimental than expected.
For example, when gas prices rose to historic highs this past summer, some people had to pay nearly twice as much a gallon just to drive to work. That means it’s harder for consumers to cash flow other purchases or continue contributing as much to their savings account. Everything feels the squeeze.
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How to minimize inflation’s impact on your personal finances
It’s understandable to feel like inflation is out of your control. After all, the government is more involved in economic growth and GDP than individual consumers. Even so, there are some steps you can take to reduce how much inflation takes a toll on your finances.
Take a look at your investments
Diversifying your investments is a surefire way to minimize the impact of a fluctuating financial market on your finances. This means spreading investments into various categories instead of going all-in on one or two financial products. Working with a wealth management professional or financial advisor can help you do this correctly if you’re concerned about managing it independently.
Another strategy you may want to consider during inflation is looking into income investments. During inflationary periods, your rate of return may actually be quite high if you are looking for dividend-paying investment opportunities in real estate or the stock market. Earning recurring income from your investment portfolio can help increase your buying power.
Avoid debt or pay it down
Debt can really sink your spending power each month if you don’t pay it down. Carrying debt when high inflation can cost you hundreds or even thousands of dollars in the long run if you don’t address it as quickly as possible.
Paying down your debt takes focus and time, and can be extra tricky when it feels like you don’t have much money in your budget to spare. However, if you start with a simple system like the debt snowball or debt avalanche, you can make a dent in your debt and buy more breathing room in your finances.
Get wise about your budget
Budgeting is a skill that requires consistent discipline. It may make sense to take a more aggressive audit of your budget during inflation. Are you really using all of the streaming services you subscribe to? Would cutting out your monthly gym membership for a few months allow you to pay down your debt more quickly?
How you budget is personal, as are the compromises you make or don’t make. Even though eating out may cost more during inflation, it may still be a necessary reward each Friday to keep you focused on the task at hand. Whether you choose to budget using the envelope method or try reverse budgeting, it is important to find a system that works for you and stick with it.
Have an emergency fund
In an emergency, you may find yourself reaching for your credit card at a time when you otherwise wouldn’t be carrying a balance. An emergency fund to buffer yourself from those expenses can help protect you from needing to carry a balance should a surprise healthcare expense pop up.
Of course, if your emergency fund is small, building it up during inflation may be trickier than normal. However, if reining in your budget and starting an emergency fund can help stave off the need to take on high-interest debt, that is time and energy well spent.
Tips for tackling inflation as a consumer
Aside from setting your finances up so that inflation’s impact on them is minimal, there are some steps you can take as a consumer to keep inflation from eating up your budget, too. Here are a few tips and strategies to try.
Practice mindful spending
Have you ever tried a spending fast or designated certain days as “no spend” days? While it may seem a bit out of the ordinary, being more mindful about your spending can be a great way to rein in your spending and avoid impulse buys that cost you more when prices are inflated.
Tracking your spending with a budgeting app or in a notebook through money diaries is another great way to get on top of your spending habits. When you better understand when, why, and what you spend on, you can take more concrete actions to reduce excessive spending in categories that don’t truly align with your priorities.
Comparison shop
If you’re already running to Target or the grocery store, buying what you need in one place can be tempting. Convenience is worth budgeting for, but if you’re trying to minimize inflation’s impact on your finances, it may be better to compare shop. Sure, Amazon Prime can get you what you need in two days or less, but if you can save $10-$20 by buying your household essentials locally and in person, those savings can add up each week.
Invest in new skills or education
Another worry some consumers have during an inflationary period is that businesses looking to cut costs or increase profit margins may cut non-essential employees. If you’re concerned that you might be on the shortlist of employees to get the axe, investing time and money in new skills or education can help you prepare for a potential job hunt. Sometimes that means getting a new degree to switch career fields or just brushing up on the latest Google Analytics certification. When you invest in yourself, you can reap the benefits with a new job or higher pay at your current place of work.
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Costs
Budgeting can be done for free (although there are budgeting apps like YNAB that cost money), but that doesn’t mean it doesn’t come with an opportunity cost. Choosing to spend your income to build up an emergency fund or pay down debt means you have less fun money to spend on other activities. While it may seem like this will keep your spending reduced long-term, once you’re not being charged high interest on your credit card, it will feel like you’ve given yourself a raise!
Also, you must pay fees if you work with a financial advisor to help manage your investment strategy to better account for inflation. Costs generally range between 0.5% and 1% depending on the brokerage you go to.
Pros and cons
Pros
- Financial security. Minimizing how inflation affects your personal finances is a great way to feel even more peace about your money. With no debt, a strong emergency fund, and a budget that allows you to live within your means, you have the financial security to sleep easy at night.
- Stronger purchasing power. When your budget is reined in, and you transition out of an inflationary period, you can have more purchasing power than you started with. This is because you’ve locked down your budget and know that you can pay for your essentials while having a surplus of money to put toward saving, investing, or other financial goals.
- Better understanding of your finances. It’s easy to be on auto-pilot during relatively stable economic times. If you have to button things down due to inflation, the lessons you learn on a spending fast or cutting out unnecessary streaming subscriptions can be powerful. Approaching the above tasks as a learning experience to really dial in your money goals can be a blessing in disguise when it comes to inflation.
Cons
- Opportunity cost. Especially when prices are higher, the opportunity cost of paying down your bills and debts can feel even more restrictive during inflation.
- Risk with income investing. Although investing in income investing can be a powerful way to increase your income, it’s not without its risks. As such, it’s important to recognize that risk is always involved with investing in certain stocks and commodities, and that risk is something you need to understand — particularly during an inflationary period.
- Takes time. If you’re impatient, you may get frustrated by how much longer paying down high-interest debt is during inflation. Even so, by keeping a positive attitude and adopting the right mindset and strategies, you can reap the rewards of minimizing how inflation impacts your finances.
The bottom line
There is a lot of uncertainty that comes with periods of inflation. After all, supply chain issues have been backed up and messy since the coronavirus pandemic began in 2020. As such, it can feel like inflation is an external force pressing its thumb down upon you as a consumer with little to no recourse.
While it’s easy to get despondent when gas, utility, and grocery costs are taking big bites from your paycheck each month, there are steps you can take to minimize the role inflation plays on your personal finances. That starts with understanding that consumer prices and interest rates are two of the most common areas of personal finance affected by inflation.
Once you understand what to look out for when it comes to inflation, there are a few different steps you can take depending on your financial situation. Paying down high-interest debt and avoiding future credit card debt are two key steps you’ll want to take to combat inflation’s impact on your wallet. Beyond that, getting on a more intentional budget or spending plan and creating an emergency fund can be two other steps to minimizing how inflation impacts your finances.
Of course, these behavioral changes are easier said than done. Remember that price increases from inflation can make it more difficult to find extra money to throw at debt or save in an emergency fund. This perspective can help you avoid getting discouraged and throwing in the towel before you’ve reaped the benefits of the above strategies. Especially at a time when inflation has been at record highs, it’s important that you take stock of the ways you can bolster your bank account against rising prices and interest rates.
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Writer
Brent Ervin-Eickhoff is a Chicago-based writer, stage director, and filmmaker with a background in digital marketing and content creation. In addition to Joy Wallet, Brent has written for Complex, Volkswagen, HowlRound, Picture this Post, and Third Coast Review, among others. He currently serves as the Associate Director of Marketing for Content Creation at Court Theatre at the University of Chicago. Brent graduated from Ball State University with Academic Honors in Writing.
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