Inflation and your income

By Finbar Garcia

LUTCF, FSS, MFA

What causes inflation? This is a question that many consumers ask.

Inflation is the rise in prices of goods and services over time. We experience this every time we visit the supermarkets, rather than other retail stores.

We, as consumers, lose purchasing power when prices rise. The ‘dollar’ does not go as far as it did before. That loss of purchasing power means that your income does not stretch as far as it used to.

When income doesn’t keep pace with rising prices, it can lead to a decline in the standard of living for most people. Those on the lower income bracket will be affected more greatly, as they spend a larger portion of their income on essential goods, and they may not have anything to buffer the increase in prices.

While we look at wage increases to assist with inflation, our savings and investments can also be affected if the returns (interest) are way below the inflation rate. If you currently earn an annual income of $90,000 and inflation is 4 per cent, you will need $93,600 to maintain the same standard of living.

In some cases, wages may be adjusted to keep pace with inflation, as collective bargaining agreements and other benefits like the Cost of Living Allowance, more commonly known as the COLA, may be indexed to inflation.

If every time wages are to be increased when inflation increases, then the cost of goods and services will also increase, as these are direct expense inputs in all manufacturing plants and services providers.

I guess you won’t want the reverse to happen, and your wages decrease because inflation and prices decreased.

How is inflation measured?

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by consumers for a basket of goods and services. This index will indicate what variety of items is or was causing the rate of inflation to rise.

On the other hand, it will indicate what goods went down, thereby creating the average index. I am sure you remembered during Covid-19, how the cost of goods were going up almost every week.

The cost of shipping had skyrocketed, demand for goods were greater than the supply; and the war in Ukraine, which is a major supplier of wheat, compounded the situation.

How can you counteract inflation?

If you want to continue enjoying your standard of living, then you need to look at your savings and investments and more importantly, where they are invested. Some areas that historically outperform high or rising inflation are real estate, energy commodities and valued stocks. Bonds and expensive growth stocks tend to lag since inflation lowers the present value of their future cash flows to investors.

If you have your cash just sitting in a regular savings account that is not giving you any interest, you should consider transferring some into a fixed deposit account that will at least give you a descent rate of return. Some fixed deposits offer as much as 4 per cent. You can also explore money market accounts. These give you the best of both worlds: higher interest rates and easy access to your funds. The Stock Market is another option that historically gives a better return, but you will need to have time on your hands to really see the value of your investment.

Regularly update your budget. With prices changing, keeping your budget up to date is crucial. Track your spending, cut back on non-essentials, and stick to your budget. Assessing your emergency fund is another good avenue, as this will function as a cushion during the hard times. Maintain at least 12 months’ income or worth of expenses to keep you from any sudden economic shifts.

Home improvement is another way, as any improvements to your home will increase the value, thereby giving you better equity in the event of future loans.

Your insurance policies, especially those with cash values, are useful where you can invest some extra cash towards future goals like an additional retirement lump sum. These are at times invested by the insurer in instruments that carry a fair return for their policy holders over time.

Don’t let inflation stop you from investing. Discover what works for you and monitor it. Cutting back on unnecessary purchases can save you a lot. So, be money smart, invest today for a better tomorrow.

Call me for more information on planning your financial future. Send your questions to myfinancialadvisor2020@gmail.com or call 620-1185.