Explainer: What to Know (and Do) About Inflation

By Sylvia Kwan

In the news a lot over the past few months: inflation. You might have heard that it’s high, and that it’s causing a lot of market volatility. So what’s going on, and what does that mean for your money? Let’s break it down.

A line chart zig-zagging upward, with a calculator, stack of cash, and % sign floating around it. Illustration.

First: What is inflation?

Inflation is the upward creep of the prices of goods and services. It usually happens because the demand for goods and services is rising faster than companies can produce and supply them. That makes them more scarce, which makes them more valuable, which pushes prices up. When wages don’t rise to match, that creates a decrease in purchasing power. (Translation: Things cost more and you’re not making more, so you can’t buy as many things.)

Inflation is often measured using a standard benchmark like the Consumer Price Index (CPI), which you might have heard of. The CPI is calculated by looking at a standard set (“basket”) of goods (food, medical care, clothing, etc) and averaging their change in price over time.

What’s going on with inflation now?

It’s higher than it’s been in 40 years, with a climb that started in late 2020. In June, the CPI was up 9.1% compared to this time last year — the fastest inflation rate we’ve seen since 1981.

In the beginning, officials thought inflation would be “transitory” (aka temporary), with the expectation that it would subside by the end of 2021. (Narrator voice: It did not subside.) It did look like it might have peaked earlier this year, and experts had hoped for a lower rate for June, but alas.

There are several things driving all this inflation. (TL;DR: increased demand, decreased supply.)

  • First, the ~supply chain~. Between pandemic shutdowns (including those still happening in China), shipping disruptions, fewer workers, etc, there just aren’t as many goods to go around.

  • Second, after staying at home so much the last two years, and with so many people getting higher salaries thanks to the Great Resignation, consumers have money to spend — and they’re willing to spend it, even though prices are going up. That not only means buying things, but also doing things — like traveling and eating out.

  • Then there are the things people have no choice but to pay for, no matter how much they cost. For example, the combination of the supply chain factors mentioned with the war in Ukraine means that food and energy (aka gas) prices have skyrocketed. Gas prices in particular were the main engine for June’s inflation jump (although we’ve seen some relief in July); meanwhile, food prices have risen 10.4% since this time last year.

  • That also includes housing. Building material and worker shortages during the pandemic, combined with the fact that everyone and their brother decided to move to the suburbs, pushed home prices way up. And now, the ripple effects of all that (plus people’s willingness to return to cities) have finally made their way to the rental market, too. In June, rent prices grew 0.8% — the steepest rise since 1986.

It’s the Federal Reserve’s job to manage inflation, and one of the main ways it can try to do that is by raising the federal funds rate. (Here’s an explainer on how that helps.) The Fed has hiked rates three times so far this year; they’re now back to pre-pandemic levels. The market had expected the Fed to raise rates again this month anyway, but with this inflation report, there’s now potential for it to be an even steeper hike than previously anticipated.

The tricky part will be slowing inflation without sending our economy into a recession (commonly called a “soft landing”). Fear that the Fed will get it wrong is one of the main things driving all of the recent stock market volatility.

What does rising inflation mean for my money?

It’s impossible to know what will happen in the future, but here are some things to think about.

Don’t keep more than you need to in cash

This is something we say anyway — but when inflation is high, cash gets less valuable, so the advice becomes even more urgent. Savings accounts barely keep up with inflation in the best of times, but with the federal funds rate only recently raised to pre-pandemic levels, even high-yield savings accounts are falling short.

Here’s what we recommend always keeping in cash (as in, in an FDIC-insured bank account):

  • Money to pay your bills

  • Your emergency fund (three to six months’ worth of take-home pay)

  • Savings for short-term goals (things you’ll need money for in the next one to two years)

If you’re the kind of person who tips a little more toward “cautious” on the risk tolerance scale, you could consider adding a bit more to your emergency fund — if things are going to cost more later, your savings might not go quite as far.

But for the rest of your money, we typically recommend investing it.

Keep calm and invest on

If you’re investing for long-term goals (those more than a few years away), we’d probably recommend that you just keep doing what you’re doing. Every period of inflation is different, and in the past, it’s affected different types of investments in different ways (which is, after all, the point of having a diversified portfolio).

We do know (and as we’ve seen over the past few months) periods of economic uncertainty tend to make the markets nervous, which can lead to volatility. So we recommend using a technique called dollar-cost averaging, which means investing regularly, a little bit at a time, no matter what’s going on in the market. You’ll end up investing when markets are up and down in a way that evens out over time. It takes the timing guesswork out of it.

Plus, we don’t know how long higher inflation will last — CPI reports like this latest one are historical (they chart past prices) and gas prices have cooled over the first few weeks in July, a slowing that could filter down to other goods and services, as well. Either way, the longer your timeline, the less inflation is likely to impact your eventual bottom line.

(By the way, when you invest with Ellevest, we take hundreds of different economic scenarios — including ones like this — into account as we build your forecast.)

Keep an eye on interest rates

As mentioned above, interest rates are rising, and they’re expected to keep rising throughout the year. That would make variable interest rates on things like credit cards go up, too. So if you can put a little extra toward your debt now, you probably won’t regret it. And if you’re considering some sort of loan with a fixed interest rate (mortgage or student loan refinance, home equity line of credit, etc), it could be good to try to lock that in now.

On the flip side, rising interest rates also lead to higher interest rates paid by savings accounts. If you have a large chunk of cash in the bank (like a complete emergency fund, for example), see if you can find a savings account paying more.

TL,DR: We don’t know how long this period of higher inflation will last. All we can do is try to make the best choices we can with the information we have — and adjust along the way.


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Sylvia Kwan

Dr. Sylvia Kwan is the Chief Investment Officer of Ellevest. She researches and oversees Ellevest portfolios and develops the algorithms behind Ellevest’s investment recommendations.