With inflation on the rise, the value of the dollar is dropping much more quickly today than it has over the past decade.

So why is inflation suddenly so high? Is this just a temporary blip on the economic map, or is it a long-term trend? And what will it mean for our personal financial planning?

Here’s what you should know about the current inflation phenomenon — what it means, why it’s happening, and what you can do to inflation-proof your finances.

What is inflation?

Inflation is what economists call it when prices go up over time. We all know that happens — one dollar today doesn’t buy anything close to what it did fifty years ago — so it might not seem like a big deal, at least on the surface.

But when you’re planning your financial future, inflation can play a big role in how much you can save and how much you’re going to need.

For example, in 1990, the median value of U.S. homes was $79,100. By the second quarter of 2021, that number had risen to $374,900.

In fact, that’s how inflation is measured — by the purchasing power of the dollar. The Consumer Price Index for Urban Consumers, or CPI-U, measures the changing prices of common necessities like groceries, energy, housing payments, and healthcare.

You might see economists talk about “core” CPI, which ignores food and energy prices, but it’s essentially the same thing — a measure of the general cost of living as that cost changes over time.

Why is inflation rising right now?

Inflation has always been part of the market economy, but the rate of inflation has been more or less stable at around 2% for the last decade. Until now. The reason everyone’s suddenly talking about inflation is because of how fast that picture is changing.

Home values increased by about 16% between 2020 and 2021 alone, and the Bureau of Labor Statistics reported the CPI in November to be 6.88% over the year before. That said, fluctuations in energy and food prices were a large part of that number. Without them, the reported core CPI in November was 4.96%.

Needless to say, that’s better, but it’s still not great. Wage-earners are already feeling the pinch of those higher food and gas prices. For retirees, the prospects are even more concerning.

But is inflation really that bad? Or are there other factors weighing in that could make the numbers seem worse than they really are?

The 2020 COVID-19 lockdowns

One explanation for what might be a temporary inflation “spike” is that prices for many services plummeted in 2020.

Lockdowns, combined with the phenomenon of millennials fleeing urban areas, reduced demand for things like urban housing and gasoline almost overnight. We should expect prices a year later to be higher by comparison.

Since the CPI measures current prices against prices for the same goods and services 12 months earlier, that makes a lot of sense. Still, it isn’t the whole story.

Supply-chain issues

Electronic device manufacturers have been suffering from chip shortages for more than a year now with no end in sight. Like any other supply shortage, that’s bound to drive up prices.

It’s easy to blame COVID-19 for that one too, but any pause in manufacturing during the global lockdowns was only a small part of the underlying problem.

As the internet of things and edge tech become more and more prominent, chips are finding their way into just about everything. Cars. Blenders. Even dog-grooming machines. So demand was on the rise even before the temporary supply interruptions.

Combine that with the fact that some enterprising tech companies snapped chips up while they could — and that only about 10% of the world’s chip supply is made in the US — and the chief executives at both Intel and IBM have stated that the shortage could continue for two years or more.

Labor shortages

Between pandemic-related unemployment and the millions of Americans who either lost or left their jobs in 2020, employers have been struggling in 2021 to find the workers they need.

If the labor force continues to skew toward remote work as job applicants turn away from public-facing jobs, the wages for those less-desirable jobs will increase, driving the price of goods higher to meet the rising cost of doing business.

How could inflation impact your personal finances?

The good news is that while you’re actively working, your salary tends to rise with inflation. As things cost more, you make more. Hopefully, those two increases balance each other out. If the price of eggs goes up by 2%, your salary goes up by 2%.

Then, as you get promotions and work your way up the ladder, you really are making more money, even relative to the fact that the cost of groceries has gone up too. If the price of eggs goes up by 2% but your promotion gives you a raise of 8%, you’re still doing better than you were before.

For retirement planning, though, inflation becomes a bigger problem. In retirement, you’re living on a nest egg. Over the course of an average year or two, you might barely notice the effects of inflation. But over a thirty-year retirement, compounding inflation can become financially significant.

Let’s say your retirement plan expects a 2% inflation rate. If you plan to spend $6,000 per month in retirement year one and your needs don’t change, you should expect to spend about $7,314 per month in year 10.

But what if inflation rises to 5% and stays there? Now your expenses in year 10 jump to $9,773. That’s a huge difference. If you expect your retirement to last some 30 to 40 years, the problem keeps, well, compounding.

If inflation rises significantly and stays high, it can be a challenge to save enough during your working years for a secure retirement, let alone to make your money last once you get there.

How to fool-proof your finances against inflation

1. Build an emergency fund

One of the most important things you can do to help your finances weather any storm is to build up an emergency fund equal to 3–6 months of your regular household expenses.

While it won’t stave off long-term inflation, an emergency fund can help you bridge short-term gaps and handle surprises without turning to high-interest debt.

2. Revisit your budget each year

Budgeting isn’t a one-and-done event. It’s an ever-changing picture of needs and cash flows. Creating a schedule of monthly, quarterly, and annual check-ins will keep you up to date with your spending, even as volatile necessities like food and gas change in price.

“I recommend that everyone revisit their budget at least annually to consider the effects of inflation on your overall financial situation!” — James A., Quicken Subscriber

3. Build your plan conservatively

Whether you’re using high-level tools like Quicken’s online retirement calculator or more powerful, personalized tools like Quicken’s Lifetime Planner, any good financial planning tool requires estimates for things like your investment returns and inflation rates.

Estimate these conservatively. Plan for returns that are lower than the historical average and inflation rates that are higher. If you can make your plan work in a worst-case scenario, anything else is just good news.

“I invest my money between 65%/35% (equities/fixed income) and 73%/27% and assume a 6.3% annual return as opposed to the average of between 7–8%. I also figure inflation at 3.5% vs the average of 3%.” — George C., Quicken Subscriber

4. Maximize your retirement contributions

The more you can save for retirement, the better. Start by maximizing your contributions to your retirement plan (or plans) and taking full advantage of any matching funds from your employer.

If you don’t have enough time (or cash) left to maximize your contributions this year, put together a plan that will let you maximize them next year, starting in January. The sooner you start, the better off you’ll be when it’s time to retire.

5. Spend wisely

While spending wisely might go without saying, it’s especially important during times of high inflation. That means being as flexible as possible.

Spending your money well isn’t just about buying supplies in bulk. It’s about looking ahead and making smart choices.

For example, if you think you might need a new vehicle, roof, or major appliance during the next year or two, start pricing your options before it becomes an emergency. Watch for major sales or interest-free events so you can buy on the best possible terms.

Your finances will also go a lot farther if you’re willing to experiment with product and service substitutions. In other words, don’t be a creature of habit.

Research and experiment with new brands, new local shops, and new solutions to your needs. Times of inflation can drive innovation as consumers look for better, less expensive choices. Be willing to take advantage of those new possibilities.

6.  Invest in stocks

Investing in the stock market can help protect your finances against inflation, especially when you invest in companies with a long history of paying generous dividends.

The stock market also has a historical track record of outperforming inflation as companies hike prices and reduce costs to keep returns high despite difficult markets.

7. Consider inflation-resistant bonds

If you want to invest in bonds during times of inflation, look into inflation-indexed US Treasury securities (Treasury Inflation-Protected Securities, or TIPS) as well as short-term bonds that will let you re-assess the market and adjust more often.

As with any other financial change, the most important thing is not to panic. Remember, the current inflation rate is at least partly due to short-term influences. If you react immediately to a short-term change and lock yourself into long-term investments, you may well come to regret it.

8. Shift into inflation-resistant markets

Within your portfolio, higher inflation may call for a shift into more inflation-resistant sectors, like energy, financials, materials, and other commodities. If you’re not an experienced trader and the idea of investing in futures contracts sounds intimidating, start researching commodities EFTs and talk to your financial advisor about your options.

9. Invest in real estate

Real estate is another historical solution to the problem of inflation. When you lock in a 30-year mortgage at the beginning of an inflation run, the value of that property benefits from the inflation hike even though your payments don’t change.

Rental properties can also be an inflation-resistant investment because rental rates tend to keep up with (and, in fact, largely define) inflation rates, whether you prefer vacation rentals, residential units, or business rentals.

As a general rule, experienced investors diversify their holdings to try to even out market fluctuations and achieve consistent performance across their portfolio as a whole.  A widely diversified portfolio often includes a mix of stocks, bonds, real estate, and private investments.

10. Model sustainable energy choices

Because energy prices rise with inflation, sustainable energy is another sector to consider if inflation continues. Businesses, in particular, will become more likely to switch to sustainable energy sources if traditional prices continue to rise.

Solar energy, for example, already pays for itself in many parts of the country with clear, high sun exposure. The time it takes for that investment to pay off decreases as traditional electricity costs rise, making it a worthwhile option to look into for your personal energy needs as well.

The more you can get off the grid before you retire (or during your retirement), the more your personal finances will be insulated from energy price fluctuations.

11. Investigate disruptive tech

On a similar note, keep an eye out for promising investment opportunities in emerging tech that could disrupt traditional systems, providing new, cheaper ways to do things — like removing credit-card fees.

In times of inflation, as old systems become cost-prohibitive, businesses and consumers alike are more willing (and even eager) to try new, innovative solutions. This gives emerging tech an opportunity to gain market share quickly — and investors a chance to capitalize on that disruption.

12. Watch for signals from the Federal Reserve

So far, Fed officials have been calling the recent rise in inflation “transitory,” suggesting that they aren’t likely to do anything about it, but that stance might be changing.

If inflation remains high and the Fed acts to counter it, by raising interest rates, for example, that could lead to a slower market — and another signal to re-evaluate your investment strategy.

Final thoughts

With the question of inflation up in the air for the near future, it’s more important than ever to keep a close eye on your finances.

Tools like Quicken and Simplifi by Quicken let you do that easily, helping you stay aware of market fluctuations, emerging trends, and their effects across your complete financial portfolio.