Understanding the Effects of Inflation on Your Personal Finances

Inflation stood at 8.5% in March 2022—the highest it's been in 40 years. The causes of inflation are complex, but factors like international conflict, supply chain bottlenecks and pent-up demand from consumers can all play a role.

The effects of inflation aren't just felt on Wall Street. They can have a big impact on daily life for everyone. Let's explore what happens when inflation rises.

Consumer spending power declines

Your spending power declines when inflation is running wild. If you've been comfortable financially, you might end up having to tighten your spending a bit. If you've been struggling up until now, inflation can cause even more of a hardship.

At times like this, it's especially important to create a budget and update it frequently as prices change. You may need to cut back on some discretionary items like entertainment, vacations and dining out if your primary bills and living costs are taking up a greater share of the pie.

Mortgages get more expensive

Raising the federal funds rate is one tool in the Federal Reserve's inflation-fighting toolkit. When the Federal Reserve makes this move, interest rates on loans—such as mortgages—rise as a result. If you're shopping for a home, you might face more expensive home loans and potentially higher monthly payments. If you're already a homeowner with an adjustable-rate mortgage, you might see your payments heading higher after your next rate adjustment.

If you're in the market for a new home, you may need to set your sights on less expensive properties or wait until rates come down before buying. And if you expect rates to keep climbing, now might be a good time to refinance.

Rents accelerate

The cost to rent a house or apartment tends to climb rapidly when inflation is on the rise. This is partly because prices are increasing in general, but it's also because more people are getting priced out of buying a home and are renting longer. This leads to heightened competition for a limited number of rentals.

If your rent is becoming unaffordable, you have a few options to address the problem. You could try to increase your income by looking for a higher-paying job or taking on a side hustle. Or you could look for a less expensive place to live, like a smaller apartment or a home that's farther away from the city.

Gas prices soar

Gas bills can be painful during periods of inflation. Not only will you pay more to fuel up your own car, but you'll also likely be charged additional fees when using taxis and rideshares.

If your employer allows remote work, you might be able to save on gas by working from home. Another possibility is to switch to a more fuel-efficient vehicle. You could also use public transportation more often if it's available where you live. Fares on buses and subways don't change frequently and might lag behind inflation for a while.

Grocery costs increase

When food manufacturers face higher costs for ingredients and transportation to grocery stores, they often pass these higher prices on to consumers—so you might pay more for the same products or notice that packages are getting smaller.

To keep your grocery bills in check, you may want to shop at wholesale clubs or select store-brand products.

Used items become easier to sell

When prices are high, people are more likely to look for used items that could be less expensive. This is actually good news if you have something to sell. If you've been meaning to let go of an old car, appliance or furniture set, this could be a great time to list it for sale.

You might also consider teaming up with a neighbor or friend to host a yard sale and offload items you no longer use.

Cash loses value quickly

If you're holding onto a wad of money at home or have cash sitting in a checking account, inflation will eat into its value quickly. You'll probably find that what seemed like a good amount of savings a few months ago isn't worth as much today.

A good way to protect your finances in times of turmoil is to move funds into accounts that pay a rate of return, like savings accounts, certificates of deposit and money market accounts. The interest you earn on these accounts generally won't keep pace with inflation, but it can soften the hit to your savings.

The effects of inflation can be far-reaching, so you may feel their impact whenever you shop, pay bills or borrow money. Consider setting up an emergency fund so you have savings to fall back on if inflation throws a wrench into your financial plans. You can open a savings account online or visit a bank branch to get started.