Forbes.com:
Should you be worried about rising prices? Maybe concerns about inflation are overblown? How can you position yourself for financial success regardless of how much prices rise?
The dramatic bout of inflation seen over the past four months is straining paychecks and generally giving people the blues. And it’s doing its part to undercut consumer confidence and the economic rebound, as seen in recent reports.
The August University of Michigan Consumer Sentiment Index dropped like a rock, falling to its lowest level in a decade, even below the reading from the onset of the Covid-19 pandemic. Meanwhile, U.S. retail sales dropped 1.3% in July, especially for expensive goods like automobiles.
The Biden administration and the Federal Reserve say higher inflation demonstrates a rebounding economy and should cool off soon. But hot inflation makes you sweat when you’re living through it—just take a quick peek at the so-called Misery Index.
Let’s take a look at who needs to worry about rising inflation, who shouldn’t be concerned and what you can do to cope with the upward march in prices.
Workers Should Worry About Inflation
- Inflation Worry Level: High
You might think workers would be feeling a lot better about their prospects. After all, employers increased payrolls by almost 950,000 in July, after adding 938,000 the month before. Hourly earnings jumped by nearly 4% year over year, and workers have been quitting their jobs in high numbers, suggesting confidence they’ll be able to find better employment elsewhere.
But if you didn’t take inflation’s impact into account, you’d be wrong. The latest inflation report showed that prices increased by 5.4% year over year in July. Wages increased, too—but not by enough to offset inflation. Inflation-adjusted earnings declined by more than one percentage point in July.
This has been a consistent theme over the past few months: In June, inflation-adjusted wages were down 2% while in May they fell 3%. Compare that to February 2020 when wages gained 3% and inflation was up just 2.3%.
A period of higher prices was always part of the Covid economic recovery forecast. Last year, Federal Reserve Chairman Jerome Powell said that he wanted prices to rise above the central bank’s 2% target for a modest period of time to reset inflation expectations.
It was inevitable that prices in May 2021 would be higher than in May 2020, when much of the economy was shut down. Supply chain breakdowns would cause shortages of certain products, driving up costs. Fed officials realized this, and forecasted that any period of high inflation would be transitory.
But transitory has morphed into the better part of 2021. The people bearing the brunt of this difficult period are those most reliant on earned income, rather than assets like stocks or real estate, to make ends meet.
Retirees Should Be Somewhat Concerned About Inflation
- Inflation Worry Level: Medium
What about those living on a fixed income? Surely they’re also at risk if prices rise, no? Well, yes, but probably not as much as you may think.
A recent study from Allianz showed that those still working were more worried about inflation in their golden years than actual retirees. Part of that may be due to an underappreciation of Social Security.
Social Security benefits represent the majority of wealth for most Americans, and it comes with a particularly nice perk: a cost-of-living adjustment (COLA) that raises your monthly check as the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a measure of inflation, goes up.
That’s especially useful now as reports indicate that the Social Security COLA could increase by 6.2% in 2022, which would be the biggest gain in 40 years.
While that’s a significant raise, the COLA might not be enough, as a recent brief by the Boston College Center for Retirement Research suggests. Medicare premiums and taxes, for instance, historically haven’t mirrored the increases in inflation.
For instance, the average annual Medicare Part B premium increase between 2000 and 2020 was 5.9%, compared to a Social Security COLA of just 2.2%. Over time that results in a lower and lower net benefit, meaning less money for blue-plate specials.
And as for taxes? The problem is that the tax thresholds aren’t adjusted for inflation and really haven’t changed in decades, even as benefits have risen.
Back when Congress began taxing Social Security benefits in 1983, just 8% of families were affected, according to Boston College’s analysis. By 2030 that number is expected to be almost 60%. All of this is to say, a higher COLA will result in more Social Security benefits, which in turn may lead to a much greater number of recipients being taxed more than was originally intended.
Investors Shouldn’t Worry About Inflation
- Inflation Worry Level: Low
It’s not like investors love high inflation, which can hurt the growth prospects of high-rising tech stocks, among others. Remember, higher prices can result in higher interest rates, which can lower the appeal of growth stocks compared to less risky alternatives.
But we aren’t there yet. Many market observers believe the Fed is right when it calls this inflation moment transitory. For instance, the 10-year breakeven rate, a gauge of what investors believe inflation will be, on average, over the next decade, sits at just 2.33%. That’s higher than before the pandemic but by no means flashing red.
Take a look at how markets have actually performed: The S&P 500 is up more than 17% this year.
“Investors have embraced the rationale that an uptick in inflation is to be expected, as the markets responded favorably to recent data releases showing improvements in [gross domestic product], employment and the start of the projected moderation in consumer price gains,” said Sam Stovall, independent investment research firm CFRA’s chief investment strategist.
Still, there are some nerves. Not only did consumer confidence and retail sales disappoint, but other metrics are pointing toward a muddled picture. For instance, the Philadelphia Federal Reserve’s business activity index fell for a fourth consecutive month in August, echoing findings from a recent report from the New York Fed.
Nevertheless, investors shouldn’t react hastily. The economy is still growing, after enduring a blink-and-you’ll-miss-it recession, and it will likely continue to do so for a while longer. The Fed projects inflation-adjusted GDP growth of 7% this year and 3.3% in 2022, so interest rates may not start rising until 2023.
And while consumers aren’t feeling especially perky now, that doesn’t mean investors are in for trouble.
“The stock market achieved close to a 30% higher return when sentiment was dismal versus when it was more optimistic [since 1988],” wrote James Paulsen, chief investment strategist at The Leuthold Group, in a recent note. “Like a wide output-gap or a high labor unemployment rate, low levels of consumer confidence suggest the economy still has significant capacity to improve, and stock prices will likely rise as confidence is restored.”
In other words, better times are nigh, at least as far as investors are concerned.
This Is Not Your Parent’s Inflation
This isn’t the 1970s. While inflation is high right now, all expectations are that price changes will return to more normal levels toward the end of the year. Those with exposure to the stock market and real estate should expect some protection while retirees can count on a higher COLA to get them through the next year.
Workers without assets, though, have it harder. That’s why it’s so important to save a percentage of your income in a diversified portfolio of low-cost exchange-traded funds (ETFs) invested for the long-haul.
Freeing up extra cash can be especially hard during this time, though there are options. For instance, parents should automatically save whatever enhanced portion of their child tax credit they’re receiving each month. Student loan borrowers should do the same with their monthly premium payments they haven’t had to make since the beginning of the pandemic. And auto shoppers should try to hang on to their used car a bit longer.
Whatever you have to give up to make your bottom line work, at least you have the knowledge that, if the Fed is indeed right, your pain should only be transitory.
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