By Dr. James M. Dahle, WCI Founder
Here's something that the whole financial world has been talking about for months: inflation and how it keeps on rising. A question:
Inflation is higher this year than it has been in years. What should I do about it?
Inflation is a general increase in the price of goods and services. While your personal inflation rate (ie., the increase in price of what you actually buy) is the one that should matter most to you, many financial figures are tied to the government’s official inflation rate, the Consumer Price Index (CPI). These include increases in Social Security taxes and benefits, the tax brackets, increases in retirement account contribution limits, and the yields of certain types of bonds such as treasury inflation-protected securities (TIPS) and series I savings bonds. Inflation, as measured by the CPI over the last year, is indeed higher than it has been in years.
In the summer of 2021, it was more than 5% on an annualized basis, whereas the Federal Reserve has stated it targets a rate of around 2%. By the beginning of 2022, inflation was hovering around 7%, and in April 2022, it had jumped to 8.3% (even into October 2022, it remained high at 8.2%).
Many blame this inflation on low interest rates, loose monetary policy, and large amounts of economic stimulus. Indeed, all of those are inflationary. However, the inflation rate is always a balance between inflationary elements and deflationary forces, such as unemployment and economic recession. The trick for the Federal Reserve is to strike that balance. When deflationary forces decrease, government needs to make a corresponding decrease in the inflationary forces it can control. However, since you are a physician and not on the Federal Reserve Board, you don’t have to control inflation—you simply have to respond to it. Here are five responses I recommend.
#1 Think in “Real” (After-Inflation) Terms
Five thousand dollars in 2020’s money is the same as $5,431 in this year’s money. Over long periods of time, inflation makes a huge difference. Many of us remember paying less than $1 per gallon for gasoline years ago. But the truth is that gasoline cost about the same back then; it’s the money that has less value. Behavioral economists call this the “money illusion.” It is natural to think in nominal (noninflationary) terms. Guard against that tendency. This is particularly important when making long-term financial projections. For example, the stock market has had an average historical return of 10%. But after inflation, that return is only 7% and even less after taxes and investment fees. If you were counting on 10% returns to meet your financial goals, you are going to be disappointed to have less purchasing power in the future than you expected, even if the stock market performs in the future as it has in the past.
#2 Ask for a Raise
The vast majority of physicians are now employees. Some surveys estimate as few as 8% of emergency doctors own their jobs as partners. If you are an employee and your paycheck is not 5% more than it was a year ago, you took a pay cut. Ask your employer to rectify that. Point out that you’re not asking for a raise; instead, you’re just asking to be paid the same as last year via a cost-of-living increase. And while you’re at it, you might as well ask for a real raise, too. Even if the job market is tighter than it has ever been, it doesn’t hurt to ask.
#3 Save More
Just like you need to be paid more, you will need to save more each year as inflation rises. I find it useful to think in terms of percentages of your gross pay. I recommend attending physicians save 20% of their gross pay for retirement, perhaps $60,000 on an income of $300,000. If you got that 5% raise, it should not be hard to save 5% more than you did last year. The government will help, too. Every year or two, retirement account contribution limits are increased. For 2022, the 401(k)/403(b) employee contribution limits increased from $19,500 to $20,500. 457(b) contribution limits also increased to $20,500. Solo 401(k) and SEP IRA contribution limits increased to $61,000. Health savings account contribution limits also increased to $3,650 (single) or $7,300 (family). However, neither catch-up contribution limits for those over 50 nor IRA contribution limits increased in 2022 due to the IRS rounding method.
#4 Take Enough Risk
You need to make sure your investment portfolio is taking on enough risk to outpace inflation. That means the majority of the assets should usually be invested in risky investments like stock index funds and real estate, with only a minority in safer assets like cash, CDs, and bonds. Some people even like to keep a small part of their portfolio in assets expected to do well in an inflationary environment, like TIPS, gold, commodities, or even the newer and extremely speculative cryptocurrencies. However, avoid the extremes when designing your portfolio. Do not make large bets that will only pay off if you can successfully predict the future.
#5 Worry a Little Less About Your Debts
While most doctors are entirely too comfortable with debt, and while debt payments prevent many of them from ever building significant wealth, inflation erodes the value of debt, especially when the interest rates on that debt are low and fixed. Inflation generally hurts savers but helps debtors. If you have 2% debt and inflation is 5%, your debt becomes worth 3% less every year. After 10 years of 5% inflation, a 2% fixed $100,000 debt is really just a $74,000 debt.
Inflation is a reality of our modern financial system. Deal with it properly so you do not fall for the money illusion and find yourself becoming less financially secure over time.
How have you hedged against inflation over the last several months? Are you worried inflation is going to keep rising? What are your strategies moving forward? Comment below!
[This article was originally published at ACEPNow.]