Inflation is scary. Grocery, gas, airfare, car buying, utilities: in so many areas, your purchasing power is shrinking while prices continue to rise.
Fear can make you want to do anything—anything—to fight back. Fortunately, many of the best steps you can take to fight inflation align beautifully with money management best practices. Here are three areas where smart strategies get even smarter as prices rise.
INVEST FOR THE LONG TERM
Advice on “inflation protection” on your investments often mentions gold, commodities and real estate. However, if you have a well-diversified portfolio, beware of short-term strategies that could backfire, says Michelle Gessner, a certified financial planner in Houston.
“Preferably stocks,” says Gessner. “Investing in stocks is one of the best hedges against inflation there is.”
Gessner notes that gold has not been a reliable hedge against inflation since the 1970s. Commodities – staples like agricultural products, fuels and metals – can be profitable when inflation rates rise, but long-term returns have been disappointing. For example, in the 20 years ended April 29, the S&P 500 stock index has more than tripled, while the Bloomberg Commodity Index is up about 30%.
Real estate has a better track record, both during periods of inflation and over the long term. However, owning real estate directly can be a hassle, which is why many financial planners recommend mutual funds, exchange-traded funds, or real estate funds that invest in office buildings, apartments, hotels, shopping malls, and other commercial properties.
But you shouldn’t overdo it, says Gessner. She recommends her clients invest 3% to 4% of their portfolio in real estate.
“Everything in moderation,” says Gessner. “More is not necessarily better.”
PAY OFF DEBT THE SMART WAY
Inflation can be good for people with fixed-rate debt like mortgages, car loans, or government student loans. As inflation erodes a dollar’s purchasing power, borrowers can pay off debt with cheaper money than they borrowed.
But even without inflation, financial planners say most people have better uses for their money than paying off debt up front at low, fixed interest rates. For example, only after you’ve exhausted your retirement savings, built up an emergency fund, and paid off any other higher-interest debt should you consider paying back a mortgage.
“Having a 3% mortgage isn’t such a bad thing if you can take the money and do something better with it,” says Gessner.
Consider targeting credit cards or other variable-rate debt instruments, which are likely to get more expensive as the Federal Reserve hikes interest rates to fight inflation. If you can’t pay off that debt quickly, try fixing the interest rate. With a personal loan, you can pay off credit cards, for example, if you have a good credit rating. If you’re struggling to pay off your debt, a nonprofit credit counselor can help review your budget and discuss options. For recommendations, see the National Foundation for Credit Counseling at www.nfcc.org.
SOCIAL SECURITY DELAY
One of the best inflation hedges retirees can have is a depleted Social Security benefit, says William Reichenstein, director of research for Social Security Solutions, a claims strategies website. Social Security benefits are adjusted annually for inflation. Thus, the higher a person’s benefit, the more money they receive from each annual cost-of-living adjustment.
The Social Security Administration increased this year’s benefits by 5.9%. The Senior Citizens League, an advocacy group for older Americans, forecast an 8.6% increase in benefits over the next year.
People can start Social Security as early as age 62, but their benefits will be permanently reduced if they apply before their full retirement age, which is currently 66 to 67. After full retirement age, people who delay their claims receive an 8% annual increase in their benefit, known as the deferred retirement credit. Benefits are maximum at age 70.
Your benefit increases by the cost of living whether you started it or not, so you won’t miss inflation adjustments if you delay your application, Reichenstein says.
Most people who make it to retirement age will pass the “break-even” point, where the larger benefit they’re getting from the delay outweighs the smaller checks they’re skipping in the meantime, Reichenstein says. It is particularly important for the higher earner in a married couple to delay as long as possible. The greater of the couple’s two benefits is the one received by the bereaved after the death of the first spouse.
Also, delaying Social Security benefits could help middle-income people reduce their overall tax burden and leave them more after-tax money to spend, Reichenstein adds.
The way Social Security benefits are taxed creates a “tax torpedo” — a sharp rise and then fall in the marginal tax rates that many retirees pay on their income. (A marginal tax rate is the amount of additional taxes paid for each additional dollar of income.) Delaying Social Security and resorting to retirement funds instead may lessen the impact of this torpedo for middle-income people, who might otherwise double their marginal tax rates. says Reichenstein.
“Goods and services are bought with after-tax dollars, not pre-tax dollars, so that’s another reason to defer a Social Security benefit,” he says.