How Inflation Impacts Your Financial Plan And What To Do About It

Before the 2020 Covid-19 pandemic, I noticed that not many of the investors I spoke with were very concerned about how the increase in the cost of goods and services impacted their daily lives. This increase is is known as inflation and since 2020, many investors have expressed concerns about it. Here is how inflation impacts your financial plan and some steps you can take to reduce its impact.

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Impact Of Inflation

As of May 2024, the U.S. Bureau of Labor Statistics reported that inflation was 3.3%. This number is right in line with averages over the last 100 years. Assuming the trend continues, if your lifestyle expenses are $50,000 per year today, they will be closer to $130,000 in 30 years.

Inflation is also not evenly distributed across all sectors. Healthcare has a long-term average inflation of 5.13%, according to Consumer Price Index data. This can present a big problem for many populations, especially retirees who are living on a fixed income. There are a few things that people can do to shelter themselves from the harmful effects of inflation.

Plan For Inflation

Sometimes, I see people who try to calculate what they’ll need for retirement on their own without accounting for inflation. They’ll say something like, “I expect a 5% return and I’ll draw down that entire return to live on. If my expenses are $50,000 per year and I don’t want to touch my principal, I need to have $1,000,000 by retirement.” The problem, of course, is that the purchasing power of the $50,000 will be severely depleted as the years go on and the investor will need to increasingly dip into that $1,000,000.

If you don’t know how to model out what inflation-adjusted numbers would look like, there are many free online tools available to ease the planning burden. For further guidance, consider speaking with a qualified financial professional.

Don’t Keep Excess Cash

When uncertainty is high, I notice that many investors opt to keep more cash than they need for emergency reserves, which is three to six months of living expenses. If you have a major purchase goal in the next three years, this is perfectly acceptable. If you do not, then you are actively losing purchasing power as time goes on. Consider assessing your intermediate and long-term goals and investing in accordance with your risk tolerance for those goals.

Stocks For The Long Run

If you have a long time before you need to start distributing and want to beat inflation in your investments, look to a diversified stock portfolio. According to Nobel Prize winner Robert Shiller’s data , if you invested $1,000 in the S&P 500 in June 1994 and reinvested all dividends, you would have $20,664.45 in June 2024. That is an annualized return of 10.62%. If you adjusted for inflation over that same period, you would still have a return of 7.89%.

Insure Excess Risk

It is possible to insure certain financial risks and even add inflation protection. If you are a homeowner and the value of your home has gone up significantly, consider working with your agent to make sure your homeowner’s insurance coverage is sufficient if disaster strikes. If you are worried that the need for care when you are older could ruin your best-laid retirement funding plans, consider looking into a long-term care insurance policy with inflating benefits.

Conclusion

Inflation can pose a significant financial risk to people who do not plan for it. If you map savings and investments needed around inflation, avoid keeping excess cash, invest in diversified stock portfolios for long-term goals, and insure excess risk, you can stay ahead of inflation and protect yourself from some of its more harmful effects.

By Cicely Jones , Contributor