If your budget has seemed tighter over the past year, you aren’t imagining things.
The reason could be inflation, which happens when prices across the country go up and purchasing power goes down. Prices have increased 5% year over year, according to the consumer price index (CPI), which is the largest 12-month jump since 2008.
Inflation can have a few effects on your day-to-day finances, but you can protect your dollars if you know what to look for.
Price of goods will suddenly increase
The most obvious hallmark of inflation is an increase in what you pay for goods and services. Over the past year, the price tag on everything from used cars to gasoline, groceries, clothes, and more has steadily gone up.
Price hikes on these goods “tend to be short-lived, since companies will eventually produce more catching up with demand,” said Ricardo Pina, founder of the personal finance blog The Modest Wallet.
To combat rising prices, consumers should strategize how they’ll spend money in the coming months, said Brent M. Weiss, a CFP and founding member of Facet Wealth. “Plan ahead for bigger expenses, and even delay some until we see things cool off.”
Cash savings will lose value
Chances are, inflation will eat away at the cash you’ve put into savings. That’s because the average interest rate on a traditional savings account — currently 0.04%, according to the FDIC — is far lower than the rate of inflation, which was 5% over the past year. So even if you haven't lost money, you can purchase less stuff with it compared to early 2020.
But you can get a better rate on your savings by opening a high-yield savings account for your emergency fund and big upcoming expenses. It’s a good idea to have three to six months’ worth of expenses in liquid savings, and not much more, Weiss said.
“After that, you really need to look at your overall plan and investment strategy to determine what is appropriate,” he said. For instance, he added, “stocks are a great inflation hedge over time.”
Interest rates for loans may rise
When inflation increases, interest rates generally go up on loan products like mortgages, auto loans, personal loans, and student loans.
In fact, “raising interest rates is one tool the government uses to combat inflation,” said David Weliver, founder of Money Under 30.
The Federal Reserve recently announced it may start hiking rates in 2023, a year earlier than expected. That’s a couple of years away, but interest rates may increase before then.
To offset the effects of rising rates, you can:
Buy now, if you can. Interest rates on some consumer loans, such as mortgages, are low right now. So “if you suspect inflation is increasing and need to borrow money, do so when rates are still low,” Weliver said.
Save for a bigger down payment. If you’re borrowing a large amount, the lender usually requires a down payment to lower their risk. Saving for a larger down payment can benefit you because it translates to a smaller monthly payment and lower interest costs, Weiss said.
Consider cheaper alternatives. Spending less is always one option for saving money — and it might even be a necessity if a higher interest rate decreases your buying power. You might, for example, need to buy a less expensive house if a higher interest rate translates to a higher monthly payment.
Inflation may impact your wages
Because the inflation rate helps measure the cost of living, some companies might use it as a benchmark for determining employee raises.
For instance, an employer might increase an employee’s salary by 1.5% to match the rate of inflation in a given year. This is known as a cost-of-living adjustment.
Unfortunately, these aren’t guaranteed and “the cost of goods often accelerates faster than wages,” Weliver said. “You may feel the squeeze if you’re not living below your means.”
Read more information and tips in our Planning section