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What you should know about inflation

How to better understand sticker shock

You held off buying a new car and taking a fun family vacation while hunkering down at home during the height of the pandemic. Now that you have a little more freedom, you want to make some long overdue purchases. But the price of things has given you sticker shock.

It turns out that many of your fellow Americans have had the same idea.

An increase in demand

Many had hoped to spend some of the money they saved while hibernating and do something fun with it — such as flying someplace tropical, road-tripping in a souped-up new SUV, or refreshing a tired area of the home.

However, building materials, chips for automobiles, and other goods that the general population hadn’t given much thought to in 2020 can’t be produced quickly in a large enough supply, resulting in shortages. As a result, prices have spiked in some areas of the economy, right when some consumers were ready to start spending again.

An auto example

Automobile manufacturers are having a hard time filling demand. The microchips that are used in cars to operate window motors and navigation systems are in short supply — and may not be back to pre-pandemic levels until 2023.1

And if you can find a new car, expect to pay more. By October 2021, dealers across the nation charged, on average, $800 above the sticker price for a new car. In comparison, in 2019, dealers charged $2,300 below the MSRP.2

Cost of essentials continues to rise

The cost of essentials, such as groceries, are also rising. In November 2021, they cost 6.4 percent more than they did a year prior. During that same time frame, ground beef and milk prices had increased 13.9 percent and 4.5 percent, respectively.3

The good news is that many economists expect inflation to moderate through 2022, perhaps falling below 3 percent by the end of the year. Keep in mind that, although inflation will return to moderate levels, prices aren’t expected to return to pre-pandemic levels.4

Since it looks like higher prices are here to stay, it’s important to learn more about the root cause of it all: inflation. It might give you a sense of control as higher prices take hold.

So what, exactly, is inflation?

Inflation is when the prices of goods and services increase over a period of time, resulting in a currency decreasing in value and purchasing power. Put simply, your dollar doesn’t go as far as it used to.5

It happens when a good or service becomes scarcer, resulting in rising costs being passed down to the seller and, ultimately, the consumer.

Experts say that a low, steady rate of inflation is healthy for the economy. For example, the Federal Reserve suggests that a 2 percent inflation rate is good. However, when it increases higher — and at a quick rate — it is a cause for concern.5 At the end of November 2021, the U.S. saw the biggest jump in annual inflation rates (6.8 percent) since June 1982.6  

What you should know about inflation

Inflation lowers the purchasing power of money, which can affect your retirement and your lifestyle over time. For example, at 3 percent inflation, a $100 grocery run will amount to $103 the following year. Let’s say prices grow by 3 percent each year. After 25 years, you’ll need $209 — which is an increase of 109 percent — to pay for those same groceries. If your income (or investments) doesn’t keep pace with inflation, your finances will take a hit.

A good benchmark for developing your inflation rate assumption is the Consumer Price Index (CPI) measured over a longer period of time and adding in a margin of 1 percent or more to that figure. Using this approach, you’ll end up with a range of 3.5 to 5 percent for your long-term inflation rate. Keep in mind that inflation and its effects are unpredictable. Work with your financial professional to keep track of the actual rate so you can make any adjustments along the way.

How you can deal with inflation

You can’t control inflation, but you can control your spending habits.

Start by adjusting and sticking to a monthly budget. For example, you might notice that a particular protein at the grocery store is getting to be more expensive. Figure out an alternative protein and do meal plans around it. Buy shelf-stable products in bulk.

Recurring monthly costs can be negotiated, such as streaming services, insurance premiums, cable bills, cell phone plans, and gym memberships. Studies show that oftentimes when consumers call to ask for a lower rate, they get one.7  

Timing is everything. Some of the sky-high building supply prices might drop in the winter months, when demand for them cools. Maybe that’s when you plan your home remodel.7

In the long run, you will want to take inflation into account when developing your financial strategy.

Simply setting aside money in a bank account may not help with your inflation worries. In late 2021, the national average rate for a savings account was 0.06 percent.8 While it may be important to have cash readily available for things like a down payment on a home, the rate of return on a big stash of cash will not outpace the inflation rate. In order to gain real value, investments must earn a rate of return that’s higher than the rate of inflation. Discuss your investment options with your financial professional. They can help guide you to make investment decisions to help you reach your goals.

It’s hard to see prices rise. But you can make the best of it by preparing yourself for what lies ahead.

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1. Preston, Benjamin. “Global chip shortage makes it tough to buy certain cars.” Consumer Reports, October 4, 2021.

2. Meitrodt, Jeffrey. “Empty lots, long waitlists, high prices: Twin Cities car market is at an extreme moment.” Star Tribune, December 4, 2021.

3. Meyersohn, Nathaniel. “Rising grocery prices force customers to buy less, change brands and switch stores.” CNN Business, December 14, 2021.

4. Choe, Stan; Bussewitz, Cathy. “Inflation is painfully high, but some relief may be coming.” Star Tribune, December 12, 2021.

5. Lewis, Ramsey. “What is inflation? Why the cost of goods rise over time and what it means for the value of your money.” Business Insider, November 11, 2021.

6. “Current US Inflation Rates: 2000–2021

7. Dickler, Jessica. “Here are some tips for beating inflation as prices start to rise.” CNBC, September 16, 2021.

8. Carlozo, Lou. “Best Savings Accounts – December 2021.” U.S. News, October 29, 2021. 

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