Coping With High Inflation: Year 2

By Barbara O’Neill, Ph.D., CFP®

An August 2021 OneOp blog post presented eight money-saving hacks to cope with inflation. At that time, the 12-month percentage change in the Consumer Price Index (CPI) was 5.3% and rising. Thirteen months later, the CPI change in September 2022 was 8.2%, after having reached a 9.1% peak in June.

Not surprisingly, rising prices are a top concern of many Americans and Personal Financial Managers (PFMs) continue to field questions from military families about making ends meet. Below are six key things for PFMs to know about inflation:

Inflation is New to Gen Y and Z – Many Americans (i.e., those born after 1990), including a large majority of service members, are experiencing high, sustained inflation for the first time ever. Inflation was in the low single digits for all or most of their lives. Therefore, they have no personal historical reference points to fall back on as they navigate higher costs for basic necessities and challenging housing markets during PCS moves.
Inflation is Regressive – Like state sales tax on purchased items, inflation hits lower-income households the hardest. Why? Price increases take a bigger chunk out of limited incomes. For example $1,000 in higher annual expenses is 3.3% of a $30,000 income (e.g., an enlisted member) and 1.6% of $60,000 (e.g., e.g., a warrant officer).
Multiple Causes of 2021-2022 Inflation – A “perfect storm” of factors caused prices to increase. They include pent-up savings and demand for purchases due to COVID-19, the Russian invasion of Ukraine (higher prices globally), Federal Reserve interest rate increases, supply chain issues, and higher labor costs.
High Inflation Will (Eventually) Subside – Historical data reported by the U.S. Bureau of Labor Statistics show that high inflation rates, even double digits in 1979-1981, are followed by moderating levels. Caution clients to avoid “recency bias” (i.e., thinking that the current inflationary environment will last forever). Many pundits are cautioning against a quick drop in CPI, however, due to inflation’s multiple causes.
Recency Bias Affects IRT – Studies have shown a positive connection between investment risk tolerance (IRT) and current market conditions; i.e., recency bias. However, IRT should be consistent over time unless someone is experiencing a major life event. Down markets are a good time to assess clients’ true appetite for risk.
Waiting May Help – In the fourth quarter of 2022, new and used car prices are slowly starting to moderate. Ditto for home and rental housing costs. If clients are patient and able to wait to make these and other purchases, they may be able to save some money. Conversely, people stuck in a bad place often make poor decisions.