Financial planning during times of inflation

By Jimmy J. Williams, CPA/PFS, CFP

The United States has experienced significant inflation for the past two years. Inflation rates are determined by the Bureau of Labor Statistics (BLS) in our country. Often you will hear individuals claim they “don’t know what inflation is but do feel it when it happens.”

One of the most widely used measures of inflation is the Consumer Price Index (CPI). This index is primarily designed to measure price changes faced by urban consumers. As a monthly published average, the index is calculated using a fixed basket of goods and services representing what Americans buy in their everyday lives such as gasoline, groceries and medical care.

Life is impacted in many forms by inflationary pressure. Such areas as family budgets, housing, automobile acquisition and usage—as well as marriage itself—may be significantly impacted by inflation.

Family budgets

Based on a family’s need for housing, transportation, food, clothing and healthcare, inflation increases the amount of money required to obtain these necessary items. In the past 12 months, the U.S. economy has suffered inflation of 8.3% as reported for August 2022. At its most basic definition, the citizens of the U.S. are paying 8.3% more for the same goods purchased in 2021. However, the compounding factor to this reduced purchasing power is that the average wage per worker in the U.S. has historically not kept pace with inflation.

For some retirees, the Cost-of-Living Adjustment (COLA) scheduled for January 2023 by the Social Security Administration will be the highest in recent history. The COLA is based on the CPI and is expected to be 8.8%.

Housing

Based on the available inventory of homes in the U.S., prices are expected to remain higher for 2022 and 2023. Single-family existing home prices have risen steadily during 2022 and, according to the National Realtor Association, reached a price increase of 15.7% over previous year values. For families who wish to invest in a home, current prices may be slightly out of reach if wages do not continue to increase in a similar manner. 

The cost of operating multi-family complexes has risen considerably during the pandemic and, consequently, rent prices have increased to compensate for the higher operating costs.  Risk managers and insurance companies have increased rates of risk for homes and apartments due to the negative impact on reserves from recent natural disasters. Insurers increase their interest rates on premiums, causing policyholders to pay more to offset the higher cost of borrowing to maintain their reserves and fund operations.

Investing

Certain types of investment assets respond with dissimilar price movements to inflation. For example, bond prices will fall as inflation rises. Bonds are debt securities issued by governments and corporations for the purposes of raising cash to finance their operations or services. Issued at a specific rate of interest that the issuer will pay to investors—called the coupon rate—bond values are impacted by the rise and fall of inflation.

Investors should diversify their portfolios while utilizing securities that resist inflationary pressure such as real estate and Treasury Inflation-Protected Securities (TIPS). Real estate is leased on a contract basis, which, many times, includes a provision for annual or periodic lease payment increases to compensate the lessor or owner for the rise in operating costs.

For example, in a commercial property lease, the lessee—the person or entity leasing the property—will sign a multi-year lease to gain benefits such as tenant improvements funded by the lessor and lower monthly lease payments. However, the lessor understands the fact that costs of operations rise on an annual basis and will typically include a step-up in lease payments at each year’s lease anniversary.

The U.S. Treasury issues many different types of bills, notes and bonds to fund the services of the government. One of the types of securities issued by the U.S. Government is called TIPS bonds. This is a bond that ties its yield to the inflation factor determined by the BLS. Every six months the TIPS yield is recalculated and will pay the new yield to holders of the bond for the next six months. These bonds require a longer holding period and the investor may be penalized for redeeming the bond prior to a specified holding period.

Stocks generally keep pace with inflation. Different risks should be evaluated prior to investing in these securities. For example, growth stocks may suffer losses due to the fact that individual investors who are impacted by inflation have less money to invest. Value stocks, having trailed returns on growth stocks over the past few years, may rebound during inflationary periods and provide a better dividend payout.  Many factors must be considered before investing in any security.

Marriage and divorce

Notwithstanding the emotional factors of marriage and divorce, the economic impact of these two actions is considerable. During inflationary periods the cost of purchasing rings, renting wedding venues and feeding the guests is higher than in times of lower inflation. This is not a reason to preclude marriage, but for this article, it is an economic consideration.

Divorce is another challenge during times of inflation. The property settlement may be a challenge when real estate values are higher and retirement account values are much lower than prior to the divorce.  Further, complications may exist as to the requirement of providing health insurance and other necessities that could cause the paying spouse financial hardship for many years. 

Conclusion

Inflation is not bad for the U.S. economy if it is moderate. Many economists believe it is critical to our efficient economy to maintain a level of inflation of around 2 – 3% annually.  However, families should review their financial plan and remind themselves of the importance of thinking long-term during times of economic distress.

The future is ahead of you. Being prepared is the best means of facing it with greater joy!

This article is for educational purposes only.  Seek the advice of qualified professionals prior to investing. Cambridge and Compass Capital Management, LLC are not affiliated. Cambridge does not offer legal and tax advice. Please consult your legal and tax advisor for specific estate and income tax planning strategies.

Jimmy J. Williams, CPA/PFS, CFP^®, is the founder and president of Compass Capital Management, LLC in McAlester, Okla. A member since 1989, Williams is a former OSCPA chair, the 2007 Oklahoma Accounting Hall of Fame inductee, the 2008 Public Service Award winner and the 2020 Outstanding Member in Business and Industry Award winner.