Inflation: Should You Actually Care?

As you might expect, the short answer is yes… but there is obviously a longer explanation. You should care about inflation as an individual, and same goes if you are a business. And notably a fintech one. There is a lot that is being said about inflation these days, with a certain degree of truth. And a lot of nonsense. There is no real way to avoid it, though: it is a hot debate after many years of relative stagnation in that area. That’s because of all the money, pretty much all over the world, that is being injected in the global economy to counter the effects of the Covid-19 pandemic. The great threat of inflation is all over the news. And one of the main reasons why Bitcoin proponents tell you to buy and hodl… But why should you actually care about it?

Bad Bad-Really, Really Bad

In itself, inflation is not a bad thing. As in everything in life, it is not a black-and-white issue. It is the natural increase of prices that tend to happen as an economy grow. It has happened for as long as we have had currencies around. A few hundred U.S. Dollars could buy you a house at some point, not so much now. Should you be scared of it? Not really.

Economists generally agree that low to moderate inflation is something to look out for. On the other hand, high or even hyperinflation as seen in Venezuela or Zimbabwe can be particularly harmful for the population, as it leads to a destructive decline of purchasing power over time.

Deflation is not particularly great either: Japan has been stuck in that situation for years in spite of aggressive actions from the central bank. Deflation generally pushes companies to cut pay or even jobs in response to lower revenues.

The 2% target

The two biggest central banks in town, that is the FED in the U.S. and the ECB in Europe, have as one of their central policy to target 2% inflation. That’s apparently the magic number that keeps everybody happy, from investors to consumers.

Recently, that historical stance has been accommodated. With so much money being injected in the economy, prices are naturally increasing at a faster pace than usual. In normal times, central banks would quickly raise interest rates to tame it… but there is a general worry that hiking main rates too early would break the momentum in the economic recovery.

That increase over the target is supposedly transitionary and, over time, the central banks are still aiming for around 2% inflation. But the truth is, even 2% means that your cash’s value is eroding by 2% every year… If it sits in a checking out, it loses value. Slowly, but surely.

What can fintech do about inflation?

There are several angles to that story, but the bottom line is, fintech companies can help customers limit the effects of inflation.

Financial education

That’s the classic “when I was a kid, a loaf of bread was 50 cents” kind of thing. You’ve heard it tons of time. And that’s why inflation is misunderstood: it is normal, prices go up over time.

Now, what is not normal is that wages do not follow inflation. That’s the biggest problem and the reason why the general population is complaining about inflation. What that means in real term is that the average Joe is not able to buy as many things as he used to: if prices go up, but salaries do not, consumers get squeezed.

That’s where fintech comes in: there is a real work to be done in educating people about what inflation is and how to counter its effects. In a no-nonsense way: don’t be fooled into investing all your savings into something because apparently inflation is a new destructive phenomenon. It isn’t.

And there are not many ways to work around it. Either increase your wages faster than inflation (which is easier said than done) or invest as much as you can (which is actually not as hard as you might think).

Forecast and financial planning

Besides asking your boss for a pay raise – and you know what the likely answer is going to be – or change job, investing is the best way to counter the effects of inflation. Before going into the realm of investing, the first thing is to do is a bit of forecasting and financial planning. Ask yourself a few questions:

What inflation rate are you trying to beat (hurdle rate)?

The inflation rate of the past 10 years is not the rate for the next decade…

How much are you able to safely invest?

Managing your liquidity and not pouring all your available cash at once.

How do you beat inflation whilst minimising your risks?

There is a risk-return trade-off here: of course, a 10%+ return on investment will get you over the hurdle rate… but what is the probability that this investment goes up in smoke?

All-in on one volatile investment (cryptocurrencies, for example) is a risky strategy. Akin to going all-in on one number at a roulette casino game. It can be a formidable bet if it goes up. But you need to be ready to lose it all or a significant portion of it.

Case in point: Bitcoin. If you went all-in last year below $10k, that’s great. If you bought after Elon Musk tweeted Tesla was buying some, not so great. What will it be 10 years from now? Who knows.

If you are not so much of a gambler, diversification is the answer – and thanks to fintech, it is not as hard as it used to be…

Invest like you mean it

So now you have nailed the planning… Here comes the execution.

Fintech has been a formidable tool to democratize investing. There are plenty of platforms that let you invest in basically all the asset classes. Some that were only available to high-net-worth individuals, like venture capital, are now accessible to retail investors starting with low entry points (sometimes as low as $10).

Build a portfolio allocation strategy, across several asset classes, and execute it rigorously.

Two things to watch out for, though: firstly, there is a clear difference between trading and investing. Robinhood incentivizes you to trade shares all day long. As long as you know that you are unlikely to make money, that’s fine. Trading is not investing for the long-run to beat inflation. Financial planning and investing accordingly is on a 10-year to 30-year time horizon.

Secondly, management fees or various maintenance costs can erode your returns over time. Beware and opt for low-cost options, likes ETFs.

What if you do not have the time or interest in building a portfolio of investments?

Robo-advisors, like Betterment or Wealthfront, provide automated, low-cost, algorithm-driven investment services.

So really, there are no excuses for not complaining about inflation…