Here are some tips to counter the impact of inflation on your finances.
Inflation has been rising worldwide; surely you have also felt the effects of increased costs. High inflation decreases the value of money you save. Your personal inflation rate may be much higher than the average consumer inflation rate of 8%. Even though moderate inflation levels benefit the economy, high inflation is detrimental for you not only as a consumer but also as an investor. According to experts, inflation will continue to remain high for some time.
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Here are some tips to counter the impact of inflation on your finances:
1. Calculate your personal inflation rate: This can be done by comparing your regular expenses between two time periods. You may also use many of the expense management tools available today. Consumer inflation is a total figure that represents the average of different spending categories. For instance, while food inflation ranges between 11-14%, rent inflation is lower. These distinctions emphasize how important it is for you to understand how rising prices affect you.
2. Reduce spending: Inflation is a very strong reason to cut back on the unimportant expenses. Analyse your expenses by examining your bank or credit card statements.
You can also apply one of the popular mental frameworks or budgeting strategies such as the 50:30:30 rule where you spend 50% on needs, 30% on wants, and save 20%, or, the zero-based budget where you list all your expenses and subtract them from your income, helping you prioritize. There are other frameworks as well to get you started in a structured way.
3. Invest in assets that offer clear, positive and real returns: Real returns are gained when you subtract the inflation rate from your indicated savings. While FDs are giving negative returns at the moment, some of your other investments might also be doing the same. To guarantee that your returns are healthy, it’s important to churn your investments regularly.
4. Not all investments are equally affected by high inflation: To control inflation, central banks increase the interest rates which affect businesses and sectors differently. Be cautious while investing in stocks/companies that depend on regular capital infusion for their business model. For example, equipment leasing/rental businesses that constantly require buying of new equipment, etc. When prices rise, sales of certain goods and brands decline. It is the businesses with good brand power that are better equipped to maintain sales at higher prices.
Leveraged businesses i.e. businesses that take on debt are likely to experience an increase in debt servicing costs which impacts their profitability. Some companies may choose to reduce debt in such times affecting their future growth prospects.
It’s important for bond investors to keep in mind that bond prices and interest rates are inversely proportional. Every type of debt instrument is affected by rising interest rates; but it is medium to longer duration debts that are more severely affected than the shorter ones. This is due to the very low price fluctuation in the short term instruments. Hence, debt instruments that are invested for a shorter period perform better with rising interest rates whereas the medium or long term instruments witness price correction.
With an increase in interest rates, real estate investments and property equities typically experience a value decline at least 60% of the times. If the cost of real estate growth is financed by borrowings, higher interest rates make the purchase costs of new assets more expensive.
5. Ask for a raise: It’s essential that you ask for an increase in your salary keeping in line with the rising costs of living. Also raise the prices of any services you offer to keep up with inflation. Commoditized services including logistics, food & dining, and other services have recently seen price hikes in pace with inflation.
