On this episode of the Millennial finance podcast Financially Well, I’ll talk about how rising inflation might impact Millennials in the months and years ahead. I’ll explore why inflation may matter to you. But I’ll also discuss the many circumstances in which you’re better off focusing on what you can control about your finances.
Dr. Shlomo Benartzi is a professor and co-head of the behavioral decision-making group at the UCLA Anderson School of Management. On October 15, he wrote an article in the Wall Street Journal entitled, “As Inflation Rises, Beware of the Money Illusion. It May Cost You a Lot.” The article begins:
“As inflation rises in the U.S., a blind spot known as the money illusion could lead many people to make serious financial mistakes.”
The “money illusion,” according to Dr. Benartzi, “refers to the fact that people typically tend to think in nominal dollars — the actual amount of money spent or earned — and not real dollars, which is the purchasing power of money after taking inflation into account.”
Many Millennials already feel anxious when their cash savings just sit for an extended period of time in a bank account. We don’t enjoy missing out on stock market growth. And we certainly don’t like not earning much interest. Concerns about inflation often play a role in these feelings. But when is it actually wise for inflation to influence a Millennial’s financial decision making?
Before getting into Dr. Benartzi’s article, I want to put his thoughts into context. I regularly discuss money with other Millennials, either as their financial advisor or through a financial wellness program. In these conversations, I actually hear very few questions about inflation. And overall, this, to me, is a good thing. Most Millennials are better served focusing on what they can control.
When you’re thinking about your money, do you consider questions such as, “Is my savings rate increasing each year?” Or, “Do I spend my money on purchases that I truly value?” Most of us have limited time and energy to devote to our finances. So we won’t help ourselves much if we fixate on future uncertainties. Inflation, interest rates, and stock market growth are too unpredictable to drive most of your financial decisions.
However, I also can’t ignore the possibility that inflation could become a serious issue. And rising inflation can have a meaningful impact on your long-term personal finances. What would that actually look like? And what action might you take in response?
Here’s the aspect of Dr. Benartzi’s article that I value most: he uses straightforward math to illustrate how rising inflation might change your financial circumstances over time.
He writes, “[The Rule of 72] tells you how many years it will take to cut your purchasing power in half. For instance, based on August’s core inflation rate of 3.6%, in 20 years (72 divided by 3.6), your current income would buy you only half as much as it does today. That means if you go out to dinner with somebody, the same amount of money that buys you two meals today would buy you only one in 20 years.”
With that in mind, let’s briefly review four areas of your personal finances where you might adjust your strategy if rising inflation continues:
You probably paid a lot for that house in Washington, D.C. or another high-cost city. Yet, the good news is that housing values do often rise with inflation. As inflation rises, then, you build equity faster — if you have a fixed-rate mortgage. Monthly mortgage payments that always remain the same enable you to benefit from this dynamic.
If you purchased life insurance or home insurance many years ago, your coverage may not protect you as you expect. The coverage amount — in dollar terms — hasn’t changed, but costs have increased.
Does your portfolio contain a relatively large amount of bonds? This is a particularly important question for Millennials who have a long investment horizon. If you’re too heavily invested in bonds, your portfolio may suffer: the prices of and/or payments from those bonds can lose value to inflation.
Many online retirement calculators don’t account for inflation. Even when they do, your inflation assumption may turn out to be wrong. As a result, the dollar amount that you think you need to save for retirement will be wrong, too.
Clearly, inflation has the potential to create an endless source of financial anxiety. Dr. Benartzi’s article discussed several ways in which you might fend off or adjust to rising inflation. Most importantly, though, he didn’t touch on two strategies that Millennials, in particular, might find useful.
Firstly, take the initiative to ask for help with investing. Confusion and self-doubt about investing is common among Millennials, especially for beginners. The longer you wait to take thoughtful action, though, the less opportunity your money has to keep up with rising inflation.
Secondly, grow your income. We understandably might feel helpless and frustrated if our purchasing power declines over time. But what if we had a plan for increasing our take-home pay when we identify a need for more savings? Consulting engagements or a side hustle both could work. Even just negotiating for larger bonuses or salary increases can make a significant difference during your earning years.
I hope Dr. Benartzi’s article and my discussion today help to put recent headlines about rising inflation into context for you and your life. You can’t do much about inflation rates. And despite recent trends, inflation in the months or years ahead may prove to have little impact on your money. But you still can remain aware about how inflation applies to your decisions. And without devoting too much of your time or energy, you can make tweaks to your personal finances — including when you grow your income — that limit the consequences.
In conclusion, heck out Dr. Benartzi’s article at The Wall Street Journal. Again, it’s called “As Inflation Rises, Beware of the Money Illusion. It May Cost You a Lot.” I encourage you to check out his research and support him on social media. And, of course, subscribe to this Millennial finance podcast to learn more about how you can improve your own financial wellness.
[Editor’s note: this article reflects the transcript (which I’ve edited for clarity) of a recent Financially Well podcast episode.]
Kevin Mahoney, CFP® is the founder & CEO of Illumint, a Washington, D.C.-based company that offers financial planning for Millennials. He specializes in navigating the new financial decisions that arise during our late 20s and 30s, such as repaying student loans, buying a house, saving for college, & learning to invest. In addition, Kevin also works as a financial wellness program provider to Millennial employees around the country, including group speaking engagements.
Visit Kevin's YouTube channel for guidance on young couples' most common financial discussions, including student loans, housing, and preparing for kids.