The state of the economy plays a big role in one’s personal finances. Given the price of healthcare, leisure, vacation, and living expenses, you would think you’ll be comfortable living off of $5,000 per month. If yes, your current financial planning seems to be going well and setting you up nice retirement.
But the economy, as we know all too well, isn’t guaranteed to stay its current course. The ebb and flow of economic activity can have a large impact on your financial planning. You have to make suitable adjustments to brace and recover from the greatest impact.
Economic factors (and other indicators) should always be considered in financial planning, especially when it comes to planning for retirement.
How can economic factors affect personal finance?
Alt text: Financial sheets of paper.
There are various factors of the economy that can affect your personal financial plan. Let’s go over some of the more important ones.
Gross Domestic Product (GDP)
The modern-day financial system is based on GDP calculations. GDP refers to the total market value of the finished goods and services produced in a country in a specific period, usually quarterly and yearly. The US, for example, releases an annualized GDP estimate for each fiscal year for the calendar year.
Due to the pandemic, global supply chains have been sluggish, and the US economy has been slow. This created a huge dent in job prospects, which increased the unemployment rate, forcing many people to adjust their financial goals. During periods of slow GDP growth, most people focus on increasing their contributions to the savings account.
Inflation plays a big role in personal finance, especially on a long-term basis. Take retirement, for instance. It’s tempting to plan based on the economic conditions of today. Yet your retirement and savings will depreciate in the next several years due to the effects of inflation.
This is why inflation is something you should always consider when planning your finances, especially when calculating investments that will generate an income once you retire. The nature of inflation lowers your profits. This means that a $3 million investment today will not have as much value later due to inflation.
You may receive the same amount payout when you retire if it is not adjusted for inflation, thereby reducing your purchasing power because you’re not able to buy less with your money. Take a look at the cost of living and how it has changed since you were younger. The new, much higher inflation rate combined with low-interest rates means the money anyone saved in a poor-performing savings account will suffer a negative effect on cash savings.
Cash savers are particularly hit badly since the purchasing power of their money decreases. For instance, if you invest an amount needed to purchase a car into a savings account for two years at a rate of 1%, but the price of your favorite car during this period goes up by 2% per year, you will have to add more money to buy the car.
High inflation can increase the price of just about everything, from groceries to mortgages and gas. The rising prices can be a huge problem for financial planning since you want to ensure your income is high enough to cover your lifestyle.
Investors should protect their investment returns and purchasing power in the long run by investing in various inflation-protected products, such as inflation-linked bonds. Investments into these products move along with the inflation rate, which means they are immune to the risk of inflation.
This isn’t to say that inflation is all that bad for investors. For those with mortgages and debts, the effect of inflation would reduce the burden of debt. Take the cost of properties, for instance.The mortgage your parents took out to purchase the property will be a fraction of what it is today, with lower borrowing requirements.
The drop in the value of the dollar
One of the biggest issues with rising inflation and an uncertain economy is the drop in the dollar’s value. Price hikes are not always a bad thing for investors. If the price of a product rises due to its popularity, it adds value to your savings. For instance, the high price of an Intel CPU isn’t just due to inflation or manufacturing. It’s also based on popularity, which increases the value for investors of Intel stock.
However, if the high cost is due to inflation and no increase in value, there will be a decrease in the value for investors. The main purpose of any investment is to increase purchasing power in the long run, but inflation puts this goal at risk. When inflation rises, the investment value decreases, and the person pays more due to the lower value of the dollar.
How different financial products are affected by the economic indicators
Alt-text: Person analyzing their financial products.
Most financial products are affected differently by inflation. Here’s what you should know.
They are most vulnerable to inflation. Many investors prefer to keep their money accessible in a savings account instead of investing in stocks, which are non-liquid assets. However, a higher inflation rate can decrease the dollar value, which means your cash won’t be as valuable. Moreover, the returns gained in a savings account do not always keep up with inflation rates. This means the cash sitting in the bank is losing value and not gaining anything.
On the other hand, stocks can be used to minimize the effects of inflation in an uncertain economy. This isn’t to say that stocks are completely immune to investment. The performance of businesses you invested in determines the stock value. When inflation increases, a company may seem to be doing well because their earnings increase. However, this isn’t an indication of their performance in the market economy.
Properties are assets that almost always withstand economic uncertainty. For instance, real estate prices are known to skyrocket with inflation. This can be a double-edged sword if the property was purchased with loans. This means that higher interest rates may lower the demand for real estate with people wanting to borrow less. So, while the price of the property may increase substantially with inflation, you may find it more difficult to find buyers willing to purchase it at the new price.
Staying ahead of the market economy
Economic factors can impact our money in various ways, so it’s important for us to take stock of our finances and safeguard our wealth whenever possible. If you’re not sure about what actions to take, we recommend hiring a financial adviser to help create a financial strategy that keeps you ahead of the market economy.
Whether you manage your own financial planning or seek the help of a professional, it’s important to have a plan in place for what you can do with your money. The market economy will fluctuate with both external and internal changes, but good planning will help you stay in the driving seat at all times.