Why Inflation is Here to Stay a While and How to Handle your Money


Photo by Shvets Anna on Pexels.com

Back in the 1970s under President Jimmy Carter we saw high inflation. This continued into the early 1980s under President Reagan. It seemed as if nothing could stop the rapid price rises. Shop girls were spending their salaries on gold jewelry, seeing that prices would rise quickly and that they could make a quick profit. Gold was hot with predictions of $10,000 per ounce gold. Gasoline prices were insane for the time if you could find it. Many people are drawing parallels between those times and today. Unfortunately, there are some big differences.

New mini-book, on presale now

I’m pleased to announce the presale of my new mini-book, Mutual Fund Sample Portfolios. Many times people are told to invest, but really don’t know how to select the funds for that portfolio. Wouldn’t it be great to have examples to look at for guidance that you could tweak and adjust for your own personal needs? This new e-book provides sample portfolios for goals like investing for retirement, saving for college, or saving up for an expense like a big vacation or a new pool. More than that, for long-range goals the methodology to manage that portfolio and adjust things as you get nearer to the goal is explained. For example, what to do when you first start a 401k, then what to do when you are 20, 10, and two years out from retiring and needing to use the money. And at only about 40 printed pages in length, it is something you could read through in a couple of hours, then refer back to as needed.

(Note, this site contains affiliate links.  As an Amazon Associate I earn from qualifying purchases. When you click on an affiliate link and buy something, The Small Investor will get a small commission for the referral.  You are charged nothing extra for the purchase.  This helps keep The Small Investor going and free.  I don’t recommend any products I do not fully support.  If you would like to help but don’t see anything you need, feel free to visit Amazon through this link and buy whatever you wish.  The Small Investor will get a small commission when you do, again at no cost to you.) 

Like today, some of the inflation in the 1970’s was being caused by high fuel prices. The Saudis controlled oil production and they were keeping supplies low to maximize their profits. There wasn’t a lot those in the US could do because we just didn’t have the capability to produce a lot domestically in comparison to what was being produced in the Middle East. Over time, however, we were able to produce a lot more domestically and reduce our dependence on OPEC.

Also, back in the early 1980s, Paul Volker was appointed the chairman of the Federal Reserve. His sole assignment was to kill inflation. It took a couple of years, but he accomplished this using the powers of the federal reserve over the rates banks charge each other and over the money supply. Inflation was stopped by raising interest rates to high levels, so high that he crashed the economy and nearly cost Reagan his reelection. In doing so, however, he cooled off the economy, allowing inflation levels to drop, then we were able to start again without the high inflation. We’ve enjoyed inflation in the low 2-4% range ever since until 2021.

Today’s inflation is largely self-inflicted. It was caused partly by the Biden Administration’s war on oil, where he cancelled pipelines and blocked drilling on federal lands. This is a purposeful effort to drive up the cost of fuel and make people change their lifestyles where they walk a lot more and use public transit if they’re poor or middle class, or drive electric vehicles if they’re rich enough to afford them. The goal is to stop people from using fossil fuels so that there is less CO2 produced. (Note, this could be done without a lot of the pain by switching the electric grid to nuclear.) This surge in fuel prices has caused a surge in prices for anything that needs to be transported, which is basically everything.

The Biden Administration has also caused a huge surge in inflation by borrowing lots of money and then handing it out to people who are not working. This means that there are fewer people making things but just as many if not more people buying things. The few people still working rightly demand more pay for their hours, driving up prices, but then also when people go to buy things, those who earned the money through work find themselves competing for goods with people who just got a check from Biden in the mail, driving up prices more.

If everyone had been working, there would be more goods to go around. As it is, everyone has money – some earned and some printed – but the goods just aren’t on the shelf. Everyone has a coupon but there are only half as many happy meals as coupons. (Note that the Biden Administration claims is has cut the deficit, but it is comparing against 2020, where lots of money was borrowed and printed to pay people who weren’t working due to the lockdowns. Spending is way up from where it was five or ten years ago. Plus, the Administration wanted about $3.5T in additional spending in the Green New Deal that wasn’t passed. Inflation might be 20% per year if it had gotten its wish.)

Today those electric vehicles would be fueled primarily by coal and natural gas, since that’s where most of our power comes from, but the idea is that we can generate more energy with solar panels and wind turbines if that is the only choice. We won’t be able to do this for everyone, but maybe if we get most people walking, we can generate enough power for the wealthy to drive electric cars charged with sun and wind.

FIRE = Financially Independent, Retired Early. Want to learn how to get FIREd and become financially independent, please consider picking up a copy of my new book, FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early  This is the instruction manual on how to become financially independent.

OK, so like in the 1980s, we can just raise interest rates, slow the economy, and bring inflation down. Sure it would be painful, but it can be done, right? Well, no. Back in the 1980’s people thought the deficit and national debt was bad, but it was tiny compared to today. In 1980 when Volker raised the Fed rate to 20%, the debt was $908B. People couldn’t comprehend it reaching the huge sum of $1T. Today the debt stands at $30.5T and growing. If we were to raise interest rates now, it would mean the rate the country needed to pay to service its debt would rise as well. This means that the amount we pay in interest on the debt would grow significantly, possibly consuming everything the country brings in with taxes. We really can’t bring in any more money with taxes, so we’d be left defaulting on the debt or having no money for anything but interest payments. So, we’re basically limited on how high the Fed can raise rates, so that weapon against inflation is basically unavailable.

Inflation is here to stay. What to do.

So, plan to live with inflation for the foreseeable future. Hopefully it won’t get any worse, but you might be seeing prices rise by 8-10% per year for the next decade or more. This will change a lot about how you need to handle your money, but there are ways to mitigate the effects somewhat. Here are some:

Don’t keep cash

Each year, any cash you have will drop in value by 10%. That means your cash will drop in value by about 50% every seven years. This includes bank accounts, because while they’ll need to start paying higher interest rates to draw savers, they’ll never pay enough to make up for inflation. If you need the money within the next year or maybe two, you might need to be in cash and just accept the loss to inflation as insurance. You should also have a cash emergency fund to pay for random things that come up. But otherwise if you don’t need the money now, it should not be in cash or in your bank. You’ll be losing money every year.

Shop your job

Inflation will mean that wages will go up. In actuality, they’ll be staying the same since the amount of stuff you’ll be able to buy will stay about the same, but the amount you can earn numerically should increase with inflation. This doesn’t mean, however, that your boss will say, “Inflation was 10% last year, so here’s a 12% raise.” Your company will be looking to control their costs, which means they’ll want to keep wages about the same as they are now. Maybe they’ll offer 4% raise this year instead of the usual 2% and hope people think they’re getting a great bonus, but they won’t be willingly giving out enough to keep up with inflation.

To get a good raise, particularly if your in the middle or upper pay ranges, you’ll need to shop around. You might need to change jobs to get the money you need to keep up with inflation. You might also be able to negotiate a better raise if you can show that you can make more somewhere else and are willing to leave if you don’t get enough where you are working. Unless your company is unusual and just give raises that keep up with inflation as a matter of policy, if you aren’t shopping around, it is likely that you’ll see your spending power drop each year by staying where you are working. And the longer you stay, the more you lose.

Want all the details on using Investing to grow financially Independent?  Try The SmallIvy Book of Investing

Invest in stocks

Right now stocks are dropping in price because investors expect interest rates to increase, which would hurt earnings and cause a recession. In addition, because inflation is increasing, investors are bidding less for shares so that future returns are higher compared to what they are investing. Basically, they want a higher interest rate for their money since they’ll be losing some of that return to inflation as well.

But after inflation rates stabilize and investors realize that the Fed is limited in how high it can raise rates, stocks will start to go up in price. They may not actually gain a lot in after-inflation dollars, but because dollars are becoming worth less, it will take more of them to buy shares in companies, which will largely hold their value. You may very well see your stock portfolio going up by 10-15% regularly over the next several years, not really gaining that much in real dollars, but at least keeping up with inflation and giving you a small return after that.

This isn’t all good. Unfortunately, capital gains taxes will still apply when you go to sell shares, and it really won’t matter if most of your gain was due to inflation and not an increase in wealth. Communist philosopher Karl Marx remarked that high inflation and high taxes were the way to destroy wealth and make everyone equal (except for those who collected the taxes and kept a big portion for themselves). Still, if you hold onto your stocks and don’t sell, you can delay when you’ll need to pay those taxes. You might also have opportunities to sell in the future at lower rates or maybe even nothing if the government decides it wants to spark spending in the future by getting people to unlock the gains they have stored up in stocks. Stocks are therefore the best option you have.

Debt isn’t bad right now

I would never advocate using debt to live beyond your means. And credit card debt is never good since the credit card companies charge enough to make a huge amount after inflation and their rates can be set where ever they wish. Buying cars on payments and taking a vacation on a home equity loan also aren’t advisable. Cars drop like a rock in value and a vacation is gone as soon as you leave the beach, so you shouldn’t be paying for these things with interest. Saving up and paying cash remains the best option. This both saves you on interest and reduces how much you spend to what you can really afford.

But if you can lock in a reasonable home loan rate, it does make a lot of sense to pay it off slowly over time since the money you’ll be paying it back with will be worth a lot less than that you’re borrowing because of inflation. Maybe when you start the mortgage payment will be 1/3rd of your paycheck, but by the time you’re done it will only be 1/6th. Know that banks understand this and they will raise rates to dull the effects of inflation, but if you lock in a loan quickly before rates rise, you might be in a great place to weather the storm, coming out way ahead on the other side.

Also, while normally you might send extra money in to pay off your mortgage loan faster, the interest payments you are paying at today’s rates are be a lot less than stocks will be returning. So, invest the money and then pay off the mortgage over time, drawing from the extra money you make investing to help. Note that investing will also give you a cushion against a job loss since you could sell off some stock to pay the mortgage if needed. In addition to the money you’ll make from your stock portfolio, your home will go up in value with inflation, so you will be making money from your stocks plus money from your home. Capital gains on homes are also treated a lot better than gains on stocks, so you might get a bit of a break in the future on taxes.

This isn’t to say that you should go out and buy a huge home to get a huge mortgage. You’ll need to pay to maintain that home, and a bigger home means a bigger yard, a bigger roof, and a bigger air conditioner. So, you might find that the costs of keeping things up might really hurt as inflation makes those things more costly if you buy too much. Plus, you’ll need to heat and cool that big home with rising energy prices Take the middle ground and buy the home you need. Just don’t be anxious to pay the mortgage off like you would be with low inflation and mortgage rates at 10%.

Have a burning investing question you’d like answered?  Please send to smallivy@smallivy.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.