Your Survival Guide to Inflation in 2022

The US is facing record-breaking inflation in 2022. In February 2022, we saw the fastest pace of annual inflation in 40 years: 7.9%. For context, inflation has historically hovered around 3% in the United States

If you’re wondering what exactly that means for you and how you can continue to succeed financially when the entire country is in a tough economic situation, keep reading, because I have the answers right here.

I’ll jump into the state of inflation in 2022 in a second, but let’s start with the basics of inflation.

What is inflation?

Inflation is a decrease in the purchasing power of money, which means that a dollar tomorrow won’t be able to buy as much as it can today. For example, a cup of coffee in 1970 cost 25 cents. Today it costs $1.59 – that is inflation at work.

Inflation is the result of the annual prices for a basket of goods and services going up. If the prices went down, it would be called deflation. One of the most common ways that we measure inflation is through the Consumer Price Index, or CPI.

The CPI is a basket of consumer goods and services, such as food, transportation, and medical care. Inflation is calculated by looking at how the price of each item changes over time. If the CPI goes up, it means your money is worth less. If it goes down, it means you can stretch a buck further.  

So, let’s say that you can buy everything in the CPI basket for $10 in 2010. In that case, a $10 bill has the power to buy the entire basket. (Pretty simple math, right?) But in 2020, the basket costs $20. That means your $10 bill can only buy half the things it could in 2010. Your money isn’t as valuable in 2020 because it can’t buy as many things. That’s what we mean when we say money loses its buying power.

Right now, we’re looking at the fastest pace of annual inflation in 40 years. The Consumer Price Index rose by almost 8% through February. I know 8% may sound small, but think of it this way: the Bureau of Labor Statistics estimates that the average American spends about $400 a month on groceries. An 8% increase adds $32 a month. That works out to an extra $384 a year, which means you’re almost paying for an extra month of groceries…but without any additional food. And that isn’t even taking gas, rent, and other prices that will be increasing into account.

What causes inflation? And why is inflation so high?

Now let’s talk about what causes inflation and, more specifically, what’s causing inflation in 2022.

To do that, we need to back up and explain a basic economic principle: supply and demand.

The laws of supply and demand determine the price of goods. When supply of a good is high, and the demand is low, prices will be low. When supply is low, and demand is high, prices will be high.

This is exactly  why prices for Peloton bikes and Nintendo Switches skyrocketed during the pandemic. A lot of people were trying to figure out how to work out at home or entertain themselves, so those products were in crazy high demand.

There was such high demand that the companies couldn’t keep up – Peloton had $230 million in backlogged orders in June 2020. Nintendo sold more than 12 million Switches by November 2020, more than a 70% increase in sales year-over-year.

By almost doubling the price of the Switch, it gave Nintendo the capital to ramp up production and simultaneously kept demand from getting out of control.

Another cause for inflation can be supply chain issues, which – as I’m sure you’re aware – we’ve seen a lot of in the past year or two.

Basically, the harder an item is to obtain, the more it’s worth. Again, it all comes back to supply and demand – if the supply is low and demand is high, then the price of that item – or anything it goes into – will rise.

As the supply of goods went down and became less available, the prices went up. We saw this happen with wood, cars, and prices in restaurants.

On top of that, post-pandemic, after people received government stimulus checks, and saved money during lockdown, now they are ready to spend enthusiastically.

All of this means that consumer demand is high and supply of goods is low, leading to – you guessed it – higher prices.

What’s the state of inflation in 2022?

Doubtless you’ve noticed prices going up, especially over the last few months.

Like I said earlier,  last February, we saw the fastest pace of annual inflation in 40 years.

Ok…how will inflation affect me?

First and most obviously, shopping is going to be more expensive. Items will cost more. If you don’t need to buy something right now - don’t. If you can limit how much you’re driving right now, do so.

The other impact will be through the form of increased interest rates.

One of the ways the Federal Reserve addresses inflation to keep the economy running smoothly is by raising interest rates. March 17, 2022, they raised its effective federal funds rate by .25%.

Not sure what that means? Ultimately, that rate influences the prime interest rate, which is what lenders use to determine how much interest you’ll pay on credit cards, mortgages, and other loans.

So, if you’re looking to get a new loan, the interest rate might be higher.

Now, if you’re already locked into an interest rate, don’t worry. You’re fine. But it’s something to be aware of if you’re considering applying for new loans in the near future.

What’s the inflation forecast? (And should I be worried?)

Inflation relies on so many factors no one can say with certainty where we’ll be by the end of this year. As I said, the Federal Reserve is taking steps to reduce inflation, so it should be safe to say that inflation won’t continue to grow as rapidly, but it’s unclear whether it will come down in a significant way soon...and right now, it seems unlikely.

Like I said, supply chain issues are expected to persist, which means that low supply will likely continue to be problematic, keeping prices up. We aren’t sure what will happen with Ukraine and Russia, but war will likely continue to drive up the prices of energy and gas in particular.

The good news is that we do see wages rising. The bad news is that wages are not rising quickly enough to keep up with the rate of inflation.

Worse, inflation often hits low-income households the hardest. For households that are already struggling to get by with the normal prices of rent, food, and gasoline, just imagine the impact when the prices of those things rises. It’s tough.

So, especially if you’re living paycheck to paycheck right now, you might want to start thinking about additional streams of income or ways you can save money.

How does inflation affect the stock market?

I’m going to be honest – historically, inflation has not been kind to the stock market. In fact, seven of the last 11 bear markets have either followed or preceded a recession.

But remember – that’s why we always tell you to invest for the long-term. Yes, the market may go down, but historically, the market has always recovered. We’ve seen some significant dips, such as the crash in 1929 and the 2008 recession, but stocks have always reached new highs in time.

So, if you can afford to, leave your money alone. Give your investments time to regain their value. The worst thing to do right now would be to sell your positions and take your money out of the stock market, so fight that urge and stay invested.

How can you invest during inflation?

Even during inflation, it is possible to make passive income through investments. Here are some investment opportunities to shield yourself against inflation:

1. Gold: Gold has often been considered a shield against inflation because it tends to hold its value.
2. Commodity-based ETFs: Commodities can include grain, precious metals, electricity, oil, beef, orange juice, and natural gas. Commodities are an indicator of inflation, so as inflation rises, so will the value of certain commodities. You can broadly invest in commodities via ETFs.
3. Real Estate Investment Trusts (REITs): REITs are companies that manage income-producing real estate. A REIT consists of a pool of real estate that pays out dividends to its investors. Property value and rent prices tend to increase with inflation; maybe you’ve noticed housing prices and rent increasing in your area. That makes real estate a safe bet during inflation. One way to invest in real estates is through REITS, and Vanguard has a great low-cost Real Estate ETF. But for the record, this is not investment advice.
4. S&P 500: Like I said, the stock market typically takes a hit during inflation. However, the S&P 500 is an index fund tracking the 500 largest companies in the US stock market, which at this time, consists largely of technology and communication companies. (They account for a 35% stake in the Index.) Both technology and communication services are capital-light businesses, so, theoretically, they should be able to weather inflation well.

Disclaimer: none of this is investment advice. These are just ideas for how you might diversify your portfolio to weather the storm of inflation.

Advice for Getting through Inflation

My parting advice is this:

1. Prioritize saving. Try to find some extra cash that you can put away to prepare before price increases get too high.
2. Don’t pull your investments (unless you absolutely have to). Yes, the market may take a dip, but the stock market has always been a rollercoaster ride. The chances are incredibly high that your investments will bounce back higher than ever if you hang onto them.
3. Don’t give up hope. It may sound cheesy, but a positive mindset is incredibly powerful. Whatever is coming up in the next few months, you are informed, strong, and capable of handling it.

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