How to combat inflation

Unless you're living completely off the grid, you've likely experienced some sticker shock at the grocery store or gas pump recently.

Although inflation has cooled down from over a year ago, you've still probably felt the effects, especially for key items like food, gasoline and electricity. You can check the year-over-year inflation rate for most consumer items at the Consumer Price Index report.^{See note1}

And while the short-term effects of inflation usually get all the headlines, the long-term effects can be even more concerning. That's why it's so important to know how to protect your money over the long run. We're here to help.

What is inflation?

Inflation occurs when there are too many dollars seeking too few goods and services in the economy, causing the prices of goods and services to increase. This results in your money being worth less over time.

When your income or assets don't keep up with inflation, you lose purchasing power. So if a week's worth of groceries costs 8% more than it did last year but your salary has only increased 3%, then you've lost 5% in purchasing power.

Some inflation is inevitable in a growing economy. Over the past 10 years, inflation has averaged about 2.5% yearly, according to Federal Reserve data.^{See note1} Currently, inflation is running higher than the historical average.

Several current events — including supply chain disruptions, government stimulus payments, the war in Ukraine and the struggling job market — have combined to contribute to the current inflationary environment here and abroad.

How can we fight inflation?

There's no easy answer to the question of how to combat inflation because it can affect just about every area of your finances. In some cases, you may simply have to accept inflation for what it is.

“In other words, wait it out,” says Robert Steen, a USAA Advice Director and CERTIFIED FINANCIAL PLANNER™ professional. “There's only so much you can cut back on certain necessities, like food or medical care.”

But there are things you can do to lessen the effects of inflation, and it starts with looking closely at your spending and budget.

How does inflation affect your finances?

The consumer price index gives a general picture of how inflation affects the average American. But inflation may affect you differently depending on where you live, your lifestyle and spending habits.

It's a good idea to use a personal inflation calculator.^{See note1} Just enter your income and some information about your monthly expenses, and you'll get a better picture of how inflation may affect your spending.

Start budgeting if you haven't already.

It'll be much easier to tell how inflation affects your spending if you budget. It doesn't matter if you use an app, keep an online spreadsheet or track your purchases by hand. Any of these methods will help you see your spending more clearly.

Budgeting will help you identify areas where you might want to change your spending practices or shop around for better prices. If you're new to it or need some practice, you can read up on how to create a budget. Or you can explore some personal budgeting tools.

Build an emergency fund.

Recessions and slow markets often happen during periods of high inflation, which can put your income at risk. In these times, it's especially important to have an emergency fund.

This usually means three to six months' worth of living expenses that you can access quickly without paying a fee.

People with multiple incomes may need just a few months' worth of expenses. But couples or single people with one income may need more of a cushion. The same goes for anyone who's particularly at risk of losing their income or whose income might vary.

If you think you might need more of a savings cushion, research ways to kick-start your emergency savings.

Avoid big purchases.

Recent home and car shoppers probably noticed these big-ticket items selling faster and at higher prices than normal. Keep in mind that housing and transportation costs taken together comprise about 50% of a typical budget, according to BLS data for the timeframe from 2019 to 2022. This same report shows that the increase from 2021 to 2022 in housing costs was 7.4%, and for transportation, 12.2%. That's why it's important to watch what your spending in these two critical areas.

“When you're navigating the market and the supply is low, you may feel pressure to purchase quicker than normal,” Steen says. “But if you're able to keep driving your current car, stay in your current home, or continue renting until the market cools and interest rates go down, that may be the best option.”

That type of environment also presents opportunities for scammers to target people looking to buy or rent online. Don't let the fear of missing out on something make you feel rushed into a decision you're not comfortable making.

If you do choose to make a big purchase during high inflation, navigate the market carefully and patiently. Find out how much home you can afford. Or determine how much car you can afford.

Diversify your portfolio.

For the past decade or so, investors didn't worry much about how inflation affected their investments. But now might be a good time to take a closer look at real returns, which is what an investment earns after taxes and inflation.

As inflation rises, interest rates typically go up, too. With rising interest rates, savers can finally enjoy meaningful returns from savings, money market accounts and certificates of deposit. But know that even though their rates are up, these accounts generally don't keep pace with inflation.

“In the short run, stocks and bond prices may be adversely affected by rising interest rates and inflation,” says Steen. “Over the long run, stocks tend to outperform inflation.”

Bond prices are inversely related to interest rates, so investors may lose money by selling bonds before they mature. But if they're holding a bond to maturity, they may not be affected since they'll eventually recoup the price of the bond plus interest.

Inflation-protected securities, or Series I savings bonds, are designed to keep pace with inflation. But they have restrictions. You can learn more about government-sponsored bonds at TreasuryDirect.^{See note1}

You can also explore mutual funds or exchange-traded funds, or ETFs. These funds aim to preserve a buyer's spending power and reduce inflation risk.

Reach out to a financial planner.

Without a financial plan, it's hard to know how to fight inflation. A good plan will give you a better idea of how inflation affects you and will help you prepare for different scenarios.

Make sure you're ready to handle inflation over the long run by taking advantage of planning resources available to you. If you're retired or planning to retire soon, talk to a USAA retirement income specialist. If you're still growing your nest egg and looking for some guidance, consider Schwab's financial planning services.

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