Combating Inflation: 7 Ways to Protect Your Net Worth Value

Inflation is probably not a metric you regularly keep an eye on but we can all reflect on times when the prices of goods were notably much lower than today. While my parents were probably grumbling at a $1.00 price tag at the gas pump during the 90’s, I was topping off my tank anywhere that offered less than $4.00 a gallon in California. 

​Inflation is a silent, but persistent force that impacts all of us. It’s not until we look back several years later though that we realize how our dollars have gotten devalued over time. 

When it comes to managing your long-term net worth growth, inflation becomes an important factor that you need to consider in your wealth management strategy. If your year-over-year growth falls behind the inflation rate, the value of your nest egg is effectively diminishing over time. 

Let’s review some fundamentals on inflation so that we can learn how to combat it in the long run.

What Causes Inflation?

Inflation refers to increases in the cost of goods and services. Price increases can be caused by several underlying factors:

Increase in demand

When demand increases for a good or service with limited supply, their corresponding prices are likely to increase as well. We’ve seen many fluctuations in demand for goods this year based on changes in consumer behavior.

​For example, when my husband and I decided to purchase an inflatable hot tub during quarantine, prices had more than doubled due to higher household demand. Another weird spending habit you see in times of crisis? Lipstick. ​

We're constantly chasing new trends and evolving our needs thanks to technology and lifestyle changes. As long as there is demand for a product and a limited or finite supply, inflation will most likely be at play.

Increase in production costs

Prices also increase when the cost of raw materials increases and this cost is passed onto consumers.

Last year when we were looking for new flooring for our bedroom, the price of wood and vinyl sourced from China were notably higher due to the impending trade war. With more complex and global supply chains, prices can be impacted by many different factors in the production and distribution process.

Built-in Inflation

Built-in inflation is a phenomenon that occurs when price increases in the past drive expectations about higher prices in the future. This becomes somewhat of a self-fulfilling prophecy as employees demand higher wages in anticipation of future inflation. Businesses subsequently then bake in price and cost increases into their products and pass them onto the consumer. 

How is Inflation Measured?

​The most popular measure of inflation is the Consumer Price Index (CPI). The Consumer Price Index takes a weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care, and tracks the change in these prices. These changes effectively reflect how our cost of living adjusts over time. 

Below is a chart that shows inflation rates since 1960 based on the Consumer Price Index. 

​Inflation spiked dramatically in the 1970’s based on the 1973 oil crisis that hiked up the price of oil by nearly 300% per barrel. Since 2012 though, inflation has stayed relatively stable, tracking at or below the 2% mark annually. Thanks to technology, globalization, and information sharing, we don't see the same type of price shocks for goods and services or raw materials that spurred higher inflation rates in former decades. 

The Federal Reserve is responsible for maintaining a stable economy and managing inflation levels through monetary policy. Low and stable inflation rates are thought to minimize unemployment rates and create better price stability.

Interest rates are intertwined with inflation rates. When inflation runs too high, interest rates are typically raised to slow down the economy and discourage borrowing. Consequently, interest rates are lowered when inflation rates run too low to encourage more borrowing and stimulate the economy. This is one of the reasons we've see relatively low interest rates over the past decade.

The Fed aims for an annual target rate of inflation of 2%. Last month, however, the Fed announced a major policy shift that would allow inflation to run moderately higher than 2% to compensate for several years of lagging growth.

​With little wiggle room to lower the rock bottom interest rates we are seeing today, the Fed has less ammunition to stimulate the economy if we hit a rough patch again in the coming years. Therefore, letting the economy run hotter than normal allows areas like unemployment improve without putting the US at risk of dangerously low or even negative interest rates.

Inflation is Not Equal Across the Board

While the Consumer Price Index is a broad measure of inflation, this does not mean that the price of all goods and services increase at the same rate. 
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Below is one of my favorite charts that shows a more granular view of inflation rates across different goods and services since 1998. 

It should be no surprise that healthcare, childcare, and advanced education are increasing at 2-3x the overall inflation rate. These services are still heavily dependent on personnel with advanced expertise in their respective fields in comparison to technological devices that can now be mass produced. 
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Did household incomes increase at the same pace of educational and medical costs? Unfortunately, no. In fact, the median household income actually decreased for a period of time between 2008 and 2016. 
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Median household income over time in 2018 dollars

For families and households navigating the educational system and healthcare needs for aging relatives, the struggle is real. As long as demand remains high for these services, inflationary pressures will continue to be rampant.

How can I combat inflation?

​We’ve now uncovered two important directives about inflation in today's environment: 
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• Inflation has the potential to increase above 2% in the coming years
• Inflation is not equal across all goods and services

Everyone should strive to grow their net worth by at least the average inflation rate of the Consumer Price Index, but those facing future educational costs and anticipated healthcare expenses will need to shoot for even higher target growth rates to avoid massive debt in the future. 

To track your net worth, I recommend using Personal Capital. This platform allows you to aggregate all of your financial assets and accounts in one place and track your net worth in real-time. 

Here are ways you can help combat rising inflation: 

1. Invest Excess Cash

Over the past few years, many banks offered high-yield savings accounts with interest rates well above annual inflation rates. You could easily stow away your excess cash in these risk-free accounts and not have to worry about your money losing value. 

Once the Fed slashed interest rates this year though, banks followed suit. Most interest rates on high-yield savings accounts barely scrape 1.00% now which is much lower than current and target inflation rates. 

If you’re sitting on excess cash, investing your money right now has a greater chance of beating the inflation rate than letting it dwindle in a savings account. 

Wealthfront, the automated investment platform I use to invest my money in a diversified portfolio, recently announced a new Autopilot feature in their suite of banking offerings. Autopilot automates the process of identifying and transferring excess cash in your account towards savings or investments. 

2. Add inflation resistant investments to your portfolio

As a long-term investor with several decades ahead of me, a few years of heightened inflation may not significantly alter the course of my long-term growth.

With more private investments available to retail investors though via crowdfunding, there’s value in continuing to diversify our portfolios with inflation friendly assets. Commercial real estate and agricultural investments offer many attractive deals that appreciate with inflation and are countercyclical or not correlated with the market. 

Publicly traded REITS (real estate investment trusts) are another way to gain exposure to the real estate market, although they are not as immune to market volatility. If you are looking for a more liquid investment and can stomach higher volatility, REITS are an alternative option to private real estate investments. 

Physical real estate is an asset that appreciates with inflation as well. If you have been thinking about purchasing a home or investment property, this is a great time to consider a home purchase. 

3. Demand more pay or switch jobs for a higher salary

With several years of stagnant or decreasing wage growth, we must be more vigilant than ever in securing equitable salaries to keep up with inflationary pressure. 

If your employer isn’t raising your pay by at least the overall inflation rate each year, it may be time to have a conversation or search elsewhere for a position with higher pay. 

4. Start a 529 Plan for Your Child

A 529 plan is a college savings account that allows you to invest after-tax money and pay no federal and state taxes on the profits when it is time to use the funds to pay for college. Participants of this program can either contribute up to $15,000 per year or $75,000 spread across 5 year periods. 

Investing in your child’s education using a 529 plan can yield much higher returns vs. setting money aside in a traditional savings account. And when inflation rates for university tuition are 2-3x higher than the overall inflation rate, you need all the help you can get. 

The latest tax laws in 2020 extended this benefit to allow $10,000 per year to be applied towards private school tuition as well. This is great news for anyone looking to capitalize on educational costs before college. 

As with any tax-advantaged account, there are always rules and restrictions on how and when you can use these funds. Always read the fine print first and make sure a 529 plan aligns with your financial goals. 

5. Evaluate the ROI of your child’s educational prospects
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These days, college is no longer just the noble pursuit of educational advancement, but a financial investment as well. With less job stability in the market, more free online education, stagnant wage growth, and costs that increase 2-3x the overall inflation rate, Ivy Leagues are beginning to lose their edge. 

The desire for prestige and pedigree might be even harder to combat than inflation. But if it’s putting you or your child into years of debt and financial distress, an expensive degree could be detrimental in the long run. 

It’s unfortunate that we have to weigh in tuition over the quality of campus food and dorm rooms. But one of the best things you can do for your child is minimize the amount of debt they will incur from educational expenses.

​Until we see this trend begin to reverse, we must accept our current reality and approach our decisions pragmatically to protect the next generation from further financial instability.
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6. Consider an HSA ​

A Health Savings Account (HSA) is a lesser known, but highly valuable investment vehicle that allow you to save and invest funds towards healthcare expenses. HSA’s are a triple win because you can contribute pre-tax dollars, let your investments grow tax free, and withdraw funds from these accounts tax free for qualified medical expenses. 

HSA’s are typically available through High Deductible Health Plans (HDHP) and this account stays with you throughout your lifetime. You’ll need to have an HDHP to contribute funds, but this money will continue to grow during the years that you do not have a high deductible plan as well.

As of 2020, individuals are allowed to contribute up to $3,550 per year and individuals with families can contribute up to $7,100 per year. Unlike Flexible Spending Accounts (FSA’s), any funds in your HSA account will roll over each year indefinitely, regardless of whether or not you leave your employer. 

With healthcare costs on the rise, HSA’s are a great way to grow your healthcare savings and keep up with inflation by investing your funds with no tax liabilities.

HDHP’s are optimal when you are in relatively good health and do not foresee any major medical care when you are under this plan. The earlier you begin a HSA, the more time you have to generate compound returns. Therefore, signing up for a HDHP and HSA in your 20's or 30's when you are more likely to be in good health and have a longer time horizon is optimal.     

7. Stay healthy

If there was any motivation to live a healthier lifestyle, it’s inflationary pressure on healthcare costs. Investing in your well-being is one of the best ways you can minimize your chances of incurring hefty medical bills down the road.

Suddenly the gym doesn’t look so bad . . .
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Fight inflation with more workouts!

​Inflation is a Force to be Reckoned With

We’ll never know what the future holds, but the best that we can do is stay informed about what is happening now, plan for what we expect, and adapt to what we see. Inflation easily sneaks up on us when it’s too late to compensate for years lost on devalued dollars. 

Your best course of action today should be to review all of your assets and identify strategies to protect your net worth from inflation. 

Let’s fight inflation together before it has a chance to fight us!

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