How Inflation Will Affect your Paycheck

Inflation refers to the increase in the prices of goods and services over time. It poses a problem because it diminishes your purchasing power and hampers the value of your money in the long run. The last few months have been catastrophic as far as inflation is concerned, with the inflation rate going as high as 8.5% for 12 months ending in July 2022. This was the highest inflation rate in the U.S. in the last four decades. According to a report by the U.S. Bureau of Labor Statistics (BLS), consumer prices rose by 8.2% ending September, down from 9.1% in June. This has directly impacted millions of Americans and their lifestyles. Another report found that people are paying $445 more every month for the same goods and services compared to last year. This amounts to a whopping $5340 per year.

The impact of inflation is not limited to your purchasing power only. It also affects your earning potential. Most people only focus on how inflation disrupts their expenses. But it is also essential to understand the repercussion of rising inflation rates on your income. The hourly earnings have dropped by 3% on average, as found in September. If inflation continues to grow, the figure could increase further. Consider consulting with a professional financial advisor who can guide you on how to protect your finances during a high-inflationary period.

Read on to learn more about how inflation affects your salary and what you can do to maintain your financial health.

What is inflation, and how is it caused?

As explained, inflation refers to a rise in prices. This usually happens in two situations – a supply shortage and a surplus of income. If there is a shortage in the supply chain, the demand for a product increases. This, in turn, increases inflation. The COVID-19 pandemic and the Ukraine- Russia war are the most significant events that have disrupted supply chains and brought on inflation in the recent past. The second scenario occurs when people at large have too much money in their hands. When there is surplus cash, people are more willing to spend. Businesses take this opportunity to hike prices and earn higher profits. Out of the two situations, the former can be more worrying as it can have unprecedented consequences on inflation rates.

The rising inflation rate is not always a bad thing. In fact, inflation of about 2% is expected and considered to be good for the economy. However, with inflation rates far exceeding the average 2%, the country is now severely crippled under the weight of rising prices which in turn is also affecting your paychecks.

How does inflation affect your salary?

The effect of inflation may not be directly seen in your income. When inflation rises, employers do not necessarily lower incomes or cut out bonuses. However, they also do not increase salaries in tandem with inflation. This impacts your purchasing power. As mentioned above, consumer prices rose by 8.2% ending September. However, their salaries were not increased by 8.2%. Therefore, their purchasing power was lost. Evidently, this affected all buyers.

Some studies indicate that the median wage of workers is around $20 per hour. Surprisingly, this has been more or less stagnant for several years. The more alarming thing here is that the median wage is generally calculated on the wages of full-time workers. This implies that a large portion of the American workforce working part-time could earn a lot less or earn inconsistently and could be negatively impacted by inflation by a higher degree.

The BLS calculates inflation every year on the basis of the Consumer Price Index (CPI). This is primarily done by analyzing spending habits on essentials like education, prescription drugs, gas, mortgage, and other similar heads. However, the cost of living can differ in different demographics. For example, the cost of living in New York is 155% more than the national average. This means that the cost of living adjustments will not suffice for people in bigger cities like New York. Evidently, your expenses will increase at a faster pace than your salary if you live in one of these cities. Further, you will also suffer a loss in retirement when you claim your Social Security benefits as they are also adjusted on the basis of Cost of Living Adjustment (COLA).

What should my salary be to match inflation rates?

Ideally, your salary should match inflation. Only then can your purchasing power be preserved. If your income stays stagnant or grows at a slower pace than inflation, you lose out on wealth in the long term. Therefore, make sure to negotiate a higher salary with your employer. Typically, employers look at aspects like attendance, performance, growth, etc., when evaluating a raise. Inflation, even though necessary, is often ignored in these decisions. However, employees can remind employers of the increasing prices and negotiate their incomes.

To understand how much of a raise is suitable to keep up with inflation, try to analyze your expenses and income minutely. Your food choices, city of residence, age, and other similar factors will impact your lifestyle needs. Keep these in mind and then search for jobs or negotiate at your present workplace.

What happens if your salary is not increased in line with inflation?

You can suffer in more ways than one due to rising inflation and stagnant income as explained below:

1. Compromised lifestyle

Spending more on the same amount of goods will force you to make cuts on the number of items you can purchase. It can be hard to ignore essential expenses like rent, electricity, insurance, gas, etc. As a result, you may have to cut out costs like travel, socializing, eating out, etc. A change to your preferred lifestyle can be demoralizing and affect your peace of mind.

2. Lower investment budget

The most evident consequence can be seen in your diminishing purchasing power. However, you will also suffer other issues, such as lower savings. With fewer funds at hand, you will be forced to adjust your investment budget too. This can result in lower retirement contributions to accounts like the 401k. Most employers match a certain percentage of the employee’s contribution. If your contributions decrease, the employer match may also decrease. Further, you may invest less in mutual funds, stocks, or bonds or be forced to liquidate some of your investments to match your present needs.

3. Increased debt

While your income remains the same in inflation, your liabilities increase. You have more expenses than usual. You may resort to loans or credit cards to accommodate them all. However, even though this may seem like an immediate relief, it may create trouble later. High-interest debt creates long-term liabilities that further push your savings rate down.

4. Low returns

Inflation affects not only consumers but also businesses. When the price of goods and services increases, companies pay more for raw materials. Further, the Federal Reserve rate is also increased to protect the economy from inflation. These factors lower the overall profits of a business. As a result, they shrink their dividends, too.

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What can you do to protect yourself from inflation?

Now that you understand how inflation affects your salary, you must also know what you can do during high inflationary periods to safeguard yourself financially. Your income is an integral part of your financial health. However, building wealth does not entirely depend on your salary. It can also be done by investing your money. As inflation starts to rise and you lose your purchasing power, your future can be jeopardized. Investment returns may drop, and your contributions may lower. Further, you also put your retirement at risk. Social Security benefits have lost their purchasing power since 2000 by nearly one-third. So, you need to invest in other assets to break even. It is strongly advised not to keep cash during high inflationary periods and instead invest your money to enable growth.

Here are some options you can consider:

1. Invest in stocks

Stocks can offer protection against inflation if invested with a long-term view. Most companies simply shift the burden of high prices to consumers. This helps them maintain stock prices. While inflation can impact some businesses, essential sectors may always see demand. It is important to look for suitable stock options and invest in them to protect your money from losing its power against rising prices. A financial advisor can help you identify appropriate sectors and companies.

2. Conceder international bonds

If the national inflation is high, you can turn to other economies to make money. It may be recommended to include global investment options in your portfolio at all times to gain sufficient exposure from other economies and markets and lower risk through diversification. However, if the country is undergoing a high inflationary period as the present, you can consider international bonds in particular. These are similar to domestic bonds, except for the fact that they are issued in different countries and currencies. You can pick a country whose currency is more potent than yours. Make sure to pay attention to the country’s political and financial health, regulation, and taxation rules.

3. Invest in gold

Gold is often known as a hedge against inflation. Gold prices move along with inflation and help you protect your money. Since gold is a commodity, its price will increase when inflation rises. Therefore, investing in gold enables you to maximize your return when inflation is high. Further, gold is a highly liquid asset and can be used in the case of an emergency if you lack the necessary funds due to a diminishing income. Moreover, just like international investments, gold also helps in diversification.

4. Invest in Treasury Inflation-Protected Securities (TIPS)

Other than international bonds, you can also invest in domestic bonds like TIPS. TIPS are U.S. Treasury bonds and are inflation-protected. Their values increase similarly to inflation, which helps you earn at the same pace as inflation. Moreover, the interest rate is fixed for the entire investment term so that you can rely on it for your varied goals with surety. The interest is paid every six months. Further, you receive the inflation-adjusted invested capital at maturity. The risk involved is also low.

5. Explore real estate investing options

Real estate investments can offer numerous benefits. Firstly, they are solid financial assets that can secure you and your future generations for years. Secondly, they have the ability to generate income that can be inflation adjusted. Rent increases with inflation. If you have a rental property, you can benefit from it by increasing the rent as the inflation rate rises. Further, you can also sell real estate at a high price if inflation is high. Real estate can be a valuable asset. But if you do not already own a property, it would be hard to buy one while inflation is high. Therefore, you can consider investing in Real Estate Investment Trusts (REITs). REITs are companies that own or manage income-generating properties. For instance, a REIT may own an office complex. The income the company earns from the rent of this office complex will be shared among all investors in the form of a dividend. If there is an increase in the inflation rate, the rent will rise, and so will dividends.

6. Consider investing in cryptocurrencies

Cryptocurrencies are another way to outpace inflation. The return from some cryptocurrencies has been astronomical, with values going as high as 770%. Compared to the inflation rate of 8.5%, this is undoubtedly a massive jump and can be helpful in not only tackling inflation but also building wealth in other scenarios. However, cryptocurrencies are incredibly volatile. They are relatively new and therefore lack any historical data or performance to rely on. They are also not government-regulated, which augments the risk involved. Thus, even though they can offer a solid hedge against inflation, it is recommended to only invest in them if you have a high-risk appetite. Further, it may also be advised to contact a financial advisor or carry out adequate research before picking a cryptocurrency for investment.

To conclude

The current inflationary period has hit extreme records. And even though this may seem like an isolated event due to unexpected circumstances like the pandemic and the Ukraine-Russia war, it cannot be undermined. Inflation impacts not only your current income but also your future financial security. Therefore, try to negotiate a high salary with your employer. If you need more clarification about how much of a raise you need to keep up with inflation, consider hiring a financial advisor to better evaluate your goals, expenses, and income first. Further, do not forget to keep an eye on the future and continue investing your money. Remember, it is vital to make your money work for you, and this can be done through consistent savings and investments only.

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