In the past year, various factors have converged to create record levels of inflation felt by many of us at the pump, at the grocery store, in the housing market, and elsewhere. As day-to-day expenses continue to rise, it’s not unreasonable to question whether some of your financial goals are still in reach. Indeed, inflation is a critical variable in building a feasible financial plan, and a few percentage points in either direction can make a big difference, particularly in places like Southern California, where the cost of living is already high. At the same time, you don’t want to have to put off your living legacy goals if you don’t have to. Fortunately, there are a few reasons to hope for some price stability in the future.
Rising Interest Rates
In response to the current inflationary environment, the Federal Reserve has indicated it will pursue a strategy of raising the federal funds rate over the next few years. Raising the fed rate is typically done in incremental raises every few months. Raising this benchmark rate is a primary tool utilized by the Federal Reserve to enact monetary policy.
The objective of this policy is to increase the cost of borrowing for both consumers and businesses, effectively reducing the amount of money circulating in the economy. With less money to buy things, lower demand should cause prices to fall or, at the very least, stop rising at their current pace. While the effect is unlikely to be immediate, it should lower inflation over the next few years. You may already be seeing the impact of rising rates if you’re in the market for a mortgage or other type of loan.
Supply and Demand
Another visible consequence of the pandemic has been stifled supply chains amid global discord and the rising demand for various goods resulting from all the money added to the economy from the different stimulus packages. As you may recall from your high school economics class – higher demand and lower supply cause prices to rise. As the pandemic recedes and supply chains are reestablished, prices should also stabilize, easing inflationary pressures. Energy prices may continue to see pressure, however, as the consequences of the war in Ukraine continue to be felt at the pump.
Time
While higher inflation is undoubtedly painful in the near term, we don't expect it to be a long-term trend. Accordingly, given the long-term nature of many living legacy plans, inflation spikes should have minimal impact on the success of a given plan. Nevertheless, one of the things we want to be conscious of as planners is the possibility of high inflation and low returns. To account for that scenario and many others, our advisors stress test each of our financial plans, utilizing a Monte Carlo analysis.
A Monte Carlo analysis is a risk analysis simulation that takes your given financial plan and applies many different market scenarios to gauge how robust the plan is. The output is then presented as a probability – virtually, in what percentage of these 1,000 different scenarios does your financial plan work? Viewing the plan through this lens allows us to answer questions like “What if there’s a market downturn right after I retire?” and “Will I be ok if inflation is high for a series of years?”
While we can’t know the future, we can do our best to be prepared for various outcomes. Stress testing your financial situation is one way to do that and gives you the freedom to move forward with some of life’s most meaningful decisions without worrying about whether or not you’ll be ok. If you’d like to learn more about planning your living legacy, we invite you to schedule a call with one of our advisors today and finally take that first step towards enjoying the wealth you’ve worked so hard to build.