One of the main reasons why at Step Up Financial we are such big promoters of personal finance is due to the sheer unpredictability of life. Having strong financial plans allows us to secure our financial futures and better mitigate the risks of certain events like job or income loss, disability or health issues.
But what happens when the financial pressure comes from macro factors like the increasing cost of living and inflation we’re currently experiencing across Australia? And how do these issues impact your financial plan?
What causes inflation?
The past few years have seen a steady increase in the cost of living for Australians, influenced by rising inflation, which in turn has created more occurrences of financial hardship. And unfortunately, it’s not looking like this inflation will slow down in the near future.
Inflation, the rise seen in prices of goods and services over a certain period of time, can be the result of a number of things. But it typically occurs when there’s a surplus of economic activity, which causes a decrease in the purchasing power of money – basically, our dollar is less valuable now than it was a decade ago.
One of the best ways to analyse if inflation is occurring is through using the Consumer Price Index (CPI), which measures the average price paid by a household for a fixed amount of goods or services, and how that price has changed over a set amount of time. The Reserve Bank of Australia (RBA) endeavours to keep the CPI balanced at somewhere between 2 and 3 percent, on average. And at the moment, we’re seeing the CPI at 6.8 percent.
So we are pretty far off where we need to be, which is a factor that contributes to the RBA’s decision to continue increasing interest rates in a bid to decrease inflation. But where does inflation even come from?
As mentioned, inflation can occur thanks to a number of different factors. But one common cause of inflation is a basic supply and demand issue.
Also known as demand-pull inflation, this is when the demand for particular goods and/or services increases above the existing supply. When this happens, it puts added pressure on demand and causes an increase in the cost of those goods and services; the price is inflated.
Another cause of inflation can also be the increase in price of imported products and materials, which increases production costs along the line and ultimately ends up increasing the cost to the consumer. Exchange rates and global events can also drive inflation.
A range of different factors are causing the current inflation increases and skyrocketing cost of living, but it can be difficult to drill down to a precise reason.
Regardless of the cause, we believe it’s crucial to know what’s happening with inflation and other factors like interest rate rises and how they might impact your financial plan. Having an understanding of this empowers you to recognise if you need to make any changes to your plan, to protect your current and future finances.
How does inflation impact your finances?
Unfortunately, but perhaps obviously, inflation tends to have a direct impact on your financial situation in a range of different ways, affecting both your purchasing power and your cost of living spend.
As prices keep rising over time, the value of money goes down, which reduces the purchasing power of your income and savings. So we begin to buy fewer goods and services with the same amount of money, or start spending more money just to maintain the way we live.
The amount of disposable income also decreases as more pressure is put on the budget, which can inadvertently encourage people to make choices that might not benefit their situation, such as applying for a credit card to help meet financial gaps as they come up.
As a result, saving becomes more challenging as the value of saved funds erodes while inflation goes up, and when paired with increasing interest rates, budget stress and instability, this creates a perfect storm of financial stress for everyone from home owners to renters.
Create a financial strategy to preserve your plan
There’s little chance of escaping the impacts of inflation, rate increases and the growing cost of living, but it doesn’t have to be all doom and gloom. There are always things we can do to bolster our financial plan against the challenges life throws at us.
So if you’re feeling concerned about how to effectively safeguard your finances in this period of uncertainty, here are some tips to get you started:
Find and invest in assets that outpace inflation
If you have an investment portfolio, allocate a portion to assets that have better chance of outperforming inflation, such as stocks, real estate and commodities. These investments have the potential to maintain and even increase their real value over time. If you don’t have a portfolio, you could consider contacting a financial planner to seek advice you on how you could sensibly start one.
Diversify your investments
Diversification is crucial in mitigating the impact of inflation. By spreading your investments across different asset classes and geographical regions, you can minimise the risk of concentration and increase the likelihood of capturing growth opportunities.
Explore inflation-protected securities
Consider including inflation-protected securities, such as Australian Government Inflation-Linked Bonds, in your investment portfolio. These bonds adjust their value in response to changes in inflation, providing a safeguard against negative effects and maintaining the purchasing power of its investors.
You should also consider your savings strategy and make adjustments where you need to. Ask yourself what your short and long-term goals are, in view of the cost of living increase and additional budget stress you might be experiencing.
Perhaps your short-term goal is to just ensure you have enough money to meet your family’s needs each month, to maintain a comfortable lifestyle without needing to give up too much of what makes you happy. In this case, you might choose to put away less money into savings than you might usually.
Or you might be focusing on the long-term, and wanting to really tighten the belt now to ensure you’ve got a good nest egg in the future. If that’s your approach, you could trim down your budget to cover just the necessities and bare minimum of comforts, putting the rest away in a high-interest savings account.
Whatever your preferred approach, it will pay to begin thinking about it now if you’re not already. Failing to plan is planning to fail, and it’s no different with finances.
You don't need to go it alone
There are so many different methods and tricks for saving more money during the harder times, but above all, it’s crucial to remember you aren’t alone. It’s a tough time for many Australians at the moment, and there is help and support available should you need it.
Whether you need some help protecting your retirement or estate plan against inflation, you’re looking to re-do your budget or you want guidance on managing your debt, contact our team of financial experts at Step Up for professional, personalised support.