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By KATHY KRISTOF
kathy.kristof@latimes.com
Do you need to worry about inflation?
Prices for goods and services have been relatively tame for the last three decades, but billionaire investor Warren Buffett recently voiced the fear of many market professionals. Inflation may not be around the corner. But, he said in a recent opinion piece, unless something is done to curb government deficits, inflation could hit with a vengeance when the economy starts to gain steam.
Those who lived through the 1970s know that inflation can be crippling, vastly boosting the cost of living without improving the quality of life. But you can reduce the potential effect on your finances by assessing and mitigating your inflation risk.
Your first step is to assess your inflation risk, said Judi Martindale, a certified financial planner in San Luis Obispo, Calif.
Not everyone is hit by inflation in the same way or with the same magnitude. Retirees may welcome inflationary times because Social Security income is inflation-adjusted and many of their costs are fixed, she said.
Inflation is likely to boost market interest rates, which could land retirees more generous investment returns on their certificates of deposit and other savings accounts.
On the other hand, young renters who owe significant sums on variable-rate credit cards could be savaged.
On the other hand, young renters who owe significant sums on variable-rate credit cards could be savaged.
The only way to assess the effect on you is to figure out which items in your annual budget would and wouldn’t be subject to rising costs.
For instance, the average family spends about one-third of its budget on housing, according to the Labor Department, which tracks household expenditures. But that expense is broken into several pieces. Your rent or mortgage would be the biggest piece, followed by property taxes (for owners), household furnishings, maintenance, utilities and housekeeping.
If you’re a homeowner with a fixed-rate mortgage, the biggest piece of your housing expense is exempt from inflation. But the smaller pieces are not. And, of course, if you’ve financed with an adjustable mortgage or a home equity line of credit, the cost of your home loan would probably rise steeply with inflation.
As for renters, even in rent-controlled areas, rent hikes are often indexed to inflation. So if inflation rises sharply, so can the cost of keeping a roof overhead.
The same holds true with the average person’s second-largest cost: transportation. If you have a fixed payment for your auto loan, you’ve stopped inflation on that part of your budget. If you’ve financed your car purchase with a home equity line of credit, your rate is probably variable and could rise. So could the costs for gasoline and repairs.
Food, clothing and healthcare are affected by inflation. But you can control the amount you spend on discretionary items.
Add up the amounts that you’ve tagged as being either fixed or discretionary and compare those with the total to determine how vulnerable you are to inflation.
If most of your costs are exempt from inflation, there’s no reason to do more. But more than half of your budget could be affected by rising costs, you might want to make some changes.
The most obvious would be to refinance variable-rate debt into fixed-rate, or simply pay off variable-rate loans.
The most obvious would be to refinance variable-rate debt into fixed-rate, or simply pay off variable-rate loans.
Because inflation is a risk and not yet a reality, there’s no need to be rash, she said. Just look for opportunities to refinance when rates are cheap. In the meantime, you might want to pare back spending to pay down debt when refinancing is impractical.
Your investment portfolio should also have an inflation-fighting component, said Marilyn Cohen, president of Envision Capital Management in Beverly Hills, Calif.
Popular inflation-fighting investments are gold and commodities, real estate and Treasury Inflation-Protected Securities.
The interest rate on TIPS floats above the consumer price index, ensuring investors that their value will keep pace with inflation, but it never exceeds inflation by much. Cohen thinks you can do better.
The other investments don’t move in lock step with inflation. But the demand for gold and commodities rises when people are concerned about maintaining their buying power, Cohen noted.
Exchange-traded funds in gold and commodities have more "bounce for the ounce" than TIPS, she said. They’re also far more volatile, however, so investors need to be quick on their feet, getting out when it appears that inflation is under control.
Image courtesy Seeking Alpha
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