Inflation is a topic that is on everyone’s mind. It is one of those issues that confronts us every time we go to the grocery store or fill up our gas tank. Although inflation is a totally valid concern, we always recommend focusing on the aspects of your financial plan that you can control. You may be asking yourself, “What changes should I make during inflationary periods?”
We have put together a guide to help you evaluate your overall financial plan and strategy when it comes to dealing with inflation.
Cash Flow Issues
Cash flow is usually the first area we start to feel inflationary pressure. There are a few areas we recommend analyzing when it comes to adjusting cash flow strategy to combat inflation.
- Evaluating Living Expenses: How have your personal expenses shifted due to higher inflation? Dust off your budget and consider areas where it may make sense to pare back or save money. Consider temporarily reducing or delaying certain unnecessary expenses if your cash flow is creating stress. Review any upcoming purchases that may be subject to price increases. Would accelerating those purchases allow you to lock in a lower price?
- Evaluating Income: For many folks on a fixed income, inflation can feel especially scary. If you are retired and receiving Social Security as your primary income source, there are some built in backstops to help you fight inflation.
Social Security benefits have built-in Cost of Living Adjustments (COLA) that can help offset the effects of inflation. However, you may also want to consider reducing portfolio withdrawals during an inflationary period if your budget allows. This is particularly important in years when the market is down.
Work with your financial planner to consider other ways to reduce portfolio withdrawals. Depending on your unique situation, it may make sense to explore other options for liquidity such as cash value in life insurance policies or a Home Equity Line of Credit (HELOC).
Evaluating your overall investment strategy during periods of high inflation is an exercise that can be beneficial to your overall financial plan. You may be wondering if there are certain types of investments that perform better during periods of high inflation. We have put together some recommendations that might make sense when inflation is a concern.
- Bond Strategies: Consider purchasing Series I Savings Bonds (I Bonds) and/or Treasury Inflation-Protected Securities (TIPS) as an inflation hedge to your portfolio. Remember that I Bonds (unlike TIPS) have zero volatility, but be mindful of their holding period requirements, purchase limits and early liquidation penalties.
When evaluating bonds to add to your portfolio, keep in mind that longer bond durations will be subject to higher volatility if interest rates rise. To mitigate some of this risk, consider allocating more toward shorter bond durations, but be mindful of the difference in yield between short-duration and long-duration bonds.
Check out a recent blog that President and Financial Planner, Melissa Joy, CFP®, CDFA® wrote about best practices and tips when it comes to purchasing an I Bond.
- Equity Strategies: The equity or growth portion of your portfolio may also be a tool to help keep up with increased cost of living. Equity investments tend to outperform bonds over the long term. Periods of market downturns can also be an incredibly useful opportunity to invest available cash into your portfolio.
When reviewing your debt strategy during times of inflation there are few things to keep in mind. Be familiar with your variable-interest-rate debts. Understand how the rate is calculated and to what extent inflation may cause your interest rate to increase. If appropriate, consider paying down variable interest rate debts or refinancing them to fixed rates.
Did you know that your tax strategy may need to shift during times of inflation or market volatility? Here are a few recommendations we make when it comes to adjusting your tax strategy to account for inflation.
- Tax Loss Harvesting: Tax loss harvesting is one strategy that the team at Pearl Planning implements when the market moves into the red. Tax loss harvesting is the process of selling a security when the market is down. This strategy allows you to capture a loss that can be used to save money on your taxes. It is important to note that this tactic is only necessary for taxable accounts and not Individual Retirement Accounts (IRAs).
If you are interested in learning more about tax loss harvesting, check out the recent blog written by Financial Planner, Hannah Near, CFP®, CPA.
- Roth Conversion Opportunities: During periods of high inflation, Roth conversions may be a tactic that makes sense to deploy. A Roth conversion allows you to shift money from a tax deferred account, such as a Traditional IRA, to a Roth IRA. Roth IRAs are considered tax-free accounts as you do not have to pay taxes on withdrawals in retirement.
Periods of high inflation often make Roth conversions attractive because it allows you to shift assets to Roth accounts at lower share prices. This tactic can potentially save you money on taxes both in the short and long term.
Insurance is another area that we recommend reviewing during high inflationary periods.
- Assess Life and Disability Coverage: Consider whether you still have adequate life and disability coverage. If so, you may want to consider adding an inflation rider to your policy, if available. Although it varies by company, this type of rider can help you maintain adequate coverage over the long term, despite the rising cost of living.
- Review Coverage on Home and Auto Policies: Evaluate whether your home and auto insurance coverage are still appropriate. Consider the effect that inflation may have on the replacement cost of your home or vehicle. Touch base with your financial planner and insurance agent to make sure your policies are still appropriate.
Inflation can impact our lives in more areas than we may originally consider. Try your best to stay calm and focused on the aspects of the financial planning process that you can control. If you find yourself needing some help in reviewing your financial plan, reach out to schedule a call with our team today. We are available and ready to help you make sure you are making the most of the current inflationary environment.
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Hannah Near, CFP®, CPA is a financial advisor at Pearl Planning. Reach out for a call today at 734.274.6744.