Inflation can eat up your savings and squeeze your budget.
Published February 2, 20225 min read
If you’re feeling the crunch from inflation, you’re not alone. In fact, inflation was ranked as the top source of financial anxiety for Americans this year, according to the 2022 Policygenius Financial Anxiety Survey. There's a good reason for it. Inflation can eat up your savings and squeeze your budget.
Prices rose 7% in 2021, according to the latest Consumer Price Index data from the Bureau of Labor Statistics. That amounts to the largest 12-month increase in overall prices since 1982. As a result of rising prices, many Americans have had to take a long, hard look at their budgets and get creative in order to make ends meet.
Inflation cost the average U.S. household $3,500 last year, according to a report from researchers at the University of Pennsylvania’s Wharton School published in December analyzing the CPI data from November 2021. That is, households had to spend an additional $3,500 in order to buy the same goods and services as they did in 2019 and 2020. And lower-income households bore the brunt of rising prices more so than higher-income ones, too.
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It’s important to keep in mind, however, that some level of inflation is not only expected, but it’s also perfectly normal. The Federal Reserve targets 2% annual inflation over the long run. “Regular inflation is actually healthy,” says Julie Hall, a certified financial planner for Vision Capital Partners. “It’s the super high inflation environment that’s not healthy,” she says.
But it’s just that type of environment that Americans are currently contending with.
Aside from the top-line $3,500 figure, the Wharton report also notes that lower-income households saw their spending increase 7%, while higher-income households spent 6% more. Among the cost increases were these stand-outs: Average food prices are up 6.1% year-over-year, and energy costs are up 33.3%.
“This report says to me, in a data-driven aspect, that people are falling behind,” says Jedidiah Collins, a certified financial planner and the founder of Money Vehicle, a financial education platform.
American households in the bottom 20% of the income range spent an additional $309 on food, $761 for energy, and $476 for shelter last year. Households in the top 5% of incomes saw bigger increases in spending: $961 for food, $1,824 on energy costs, and $1,607 for shelter.
The key takeaway from the analysis, despite differences in income levels, is that inflation clearly eroded Americans’ purchasing power in a way that hasn’t been seen since the early 1980s. In fact, millions of Americans have never experienced a high-inflation environment. According to Census data the median age of the nation’s population in 2019 was around 38 years old. As such, millions of people may not know what to expect next — or what they can do to shield themselves.
In this case, inflation is the result of a combination of supply chain problems, labor shortages, and pandemic-related stimulus measures, among other things. Interest rate hikes are the primary tool in the Fed’s arsenal for getting price increases under control.
“Supply has shrunk, and demand has increased during the pandemic as interest rates have been low, and stimulus measures have given many people some extra cash,” Collins says. “It’s Econ 101 — right now, supply is being stymied and demand has remained elevated.” That, in large part, has stoked price increases.
As for what’s likely to happen next, the Federal Reserve signaled it will raise interest rates in an effort to slow price increases. By raising interest rates, the Fed makes it more expensive to borrow money. If it’s more expensive to borrow, fewer people are likely to do so and then make purchases. The overall effect is lower demand for goods and services.
Interest rates in the U.S. have been at 0% since March 2020, near the start of the pandemic. They haven’t been above 2.5% since early 2008, either. But what you need to know about the Fed’s coming rate hikes is that effectively, the government will attempt to slow the economy down by suffocating demand (to a degree), which should hopefully stymie price increases.
The big question for everyone in a high-inflation environment is this: What, if anything, can you do about it?
In terms of paying less for goods and services, not much, unfortunately, other than being proactive about your spending. “Review your budget,” Hall says, as that’s “the most important thing you can do.” Hall also recommends reviewing your investment portfolio allocations to make sure you’re comfortable with your holdings.
One other thing you can do if you have extra cash sitting in savings, Hall says, is to take a look at Series I Savings Bonds from the Treasury — these bonds are designed to protect your money from inflation, and the current interest rate for I Bonds purchased before April 30, 2022, is 7.12% for six months.
Going forward, Collins says that perhaps the best thing people can do is to anticipate future inflation and build anticipated price increases into their financial outlooks. “Always incorporate inflation into your financial plan,” Collins says. He suggests “anticipating price increases of between 3% and 3.5% per year.”
Finally, Hall says to try and use this period as a learning experience, especially given that many Americans have never seen inflation at such high levels. “This can be a learning experience. Any time we live through anything, even if it’s difficult, we’ll grow as a result — it’s the same with different cycles in the economy,” she says.
“Hopefully we learn, if anything,” she says, “that people need to make sure they have some cushion in their budget.”
Image: damircudic / Getty Images
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