Inflation is a quiet force that gradually erodes the value of money; what costs KES 100 might cost KES 120 today. Whether it is a company that is planning to expand its operation or an individual that intends to save, the subject of Inflation must influence the decision. The research by Sean Ross highlights that medium Inflation can help indicate that the economy is doing well. Still, if this Inflation is not controlled, it leads to corrosion In savings, puts pressure on budgets and makes investment decisions complex. In this article, we are going to look at the impact of Inflation on business and individual strategies.
What is Inflation?
Inflation refers to the consistent increase in the price of goods and services over time in an economy. When Inflation occurs in a nation, the purchasing power of money is lost in such a way that the amount of goods that can be exchanged for a given amount of money today cannot buy the same amount of goods tomorrow.
Key Effects of Inflation
Weakening the Purchasing Power
High and uncontrolled Inflation leads to increased prices of goods and services. This makes the households require more income so as they can maintain their current living standards, resulting in a reduction in the spendable income as more money will be spent on maintaining the living standards, compelling them to change their spending habits and make budgets on their spending. A good example is that of the United States, whereby, according to Forbes, the rate of Inflation in the United States in May 2024 reached 3.3%. This affected the spending behaviour and financial planning of United States citizen as they needed to spare more income to maintain their living standards.
High Interest Rates
This is a method that a government uses to control Inflation. It uses central banks, which instruct commercial banks to increase interest rates as they aim to reduce the amount of money in the economy. The increased interest rates increases the cost of loans, and customer spending is reduced.
Effects on Investments
The real rate of return is affected by high Inflation in any economy; this affects the inventors as the amount of return the investor gets is already eroded. For instance, in an economy where there is high Inflation, if an investor earns a rate of return of 6% and the rate of Inflation is 3%, the real rate of return on this investment is 3%. This will discourage the amount of investors in a particular county.
Effects of Inflation on Personal Financial Strategies
The Type of Investments to Venture
An individual can invest and grow their wealth during a period of Inflation by simply investing in options of investments that are Inflation-resistant. This includes:
- Real estate– real estate assets usually during Inflation they appreciate in price, making them an effective mitigator of the risk of Inflation. Additionally the rental revenue tends to increase over hence benefiting an individual.
- Treasury inflation-protected securities are the bonds issued by the government that have been adjusted for Inflation. In this kind of bonds when the consumer price index increases, the corresponding return also increases so as to help in purchasing power maintenance.
- Stocks- this mainly applies when an Individual has invested in shares of a company that has a strong pricing power; during Inflation, the company is able to adjust their prices and thus still gets high-profit margins; they are not infected by Inflation to a higher extent.
Management of Debt
During Inflation, the interest rates increase, which makes the cost of borrowing very high. Thus, an individual needs to make decisions on which type of loan to take and when to take it. Additionally, households that have the loans with fixed interest tends to pay less amounts in real terms since the money paid back has loosed the value compared to the time one borrowed it.
Budget and Saving Adjustments
Inflation increases the price of goods and services, which makes the living standards more expensive. This makes an individual to makes necessary adjustments on their savings like, decreasing the amount of money they save, and going for saving products that will offer them higher returns above the inflation rates. Additionally, households will consider restructuring the budgets so as to reflect the high costs of living.
Retirement Plans
Retirement plans are an individual’s long-term financial goals. Rising rates of Inflation will highly affect individual retirement plans, whereby a person will be required to adjust his retirement portfolio so that it can reflect the current rate of Inflation and the higher cost of living in the future. For instance, a person will required to increase the amount of money saved as retirement savings, Adjust expected disbursement rates, and Factor in inflation-adjusted earnings.
Insurance Coverage and Costs
As indicated by Cassidy Horton, Insurance, particularly life and health insurance, tends to be affected during the inflation period as insurance premiums amount and the sufficiency of the coverage are affected. An individual is then needed to ensure that the Coverage limits are aligned with current replacement or medical costs by continuing to review the policies. Additionally, one must be prepared for increased premium payments when the rate of inflation increases.
Effects on Business Financial Strategies
Adjustment of Prices and Costs
During the period of Inflation, the cost of factors of production are relatively high, which increases the cost of inputs. This creates a dilemma in many businesses as they try to manage the increased cost of production and set reasonable prices for the products so as to remain competitive in the market. This requires a business to use cost optimization techniques, use strategic price adjustments, and reevaluate the terms with the suppliers so as to enhance and reduce the cost of production, thus balancing prices to avoid losing customers in the market.
Debt and Financing Strategies
During Inflation, the interest rates increase, making borrowing more expensive, thus hindering businesses from borrowing money for various reasons like expansion. Instead, a business will look for alternative sources to acquire capital, like issuing shares. However it will be advantageous to the businesses that has an existing loan with fixed interest rate because repayment amount will be less in real terms.
Compensation Planning
As inflation rates increase, the cost of living increases also, thus reducing the real income of households. The households will then pressure the business to offer them more and better wages and salaries. For the business then to ensure its employees are satisfied, it’s forced to make adjustments to its compensation plans like offering cost of living allowances, adjusting their compensation packages, and introducing more incentives based on performance. This will ensure that the wages and salaries maintain high living standards.
Product Strategy and Demand
Uncontrolled Inflation leads to a consistent increase in the price of goods and services. This results in a change in the behaviour of the customers. Most of the customers will start only buying essential goods, thus reducing the demand for other goods in the market. This requires a business to do market research so that current market trends can be understood to help the company design their products to match the preferences and current needs of the customers. Additionally, it will be required to adjust its pricing strategy so that it can meet the current pockets of its customers.
Strategies to Mitigate the Impact of Inflation
Cutting Non-essential Expenses
According to Karcy Noonan Individuals need to prioritize spending on essential needs and enhance strict budgeting habits so as to help cut off unnecessary spending. Business also need to cut unnecessary expenses and streamline their processes and focus on investing on higher return than inflation rates investments.
Strategic use of long-term fixed-rate borrowing
Business and individuals should take long term loans with a fixed interest rate before inflation rate when the interest is low. Use this funds to invest in high return investments and also in expansion of the business. When inflation rate increase later they will repay back the money at fixed interest rate which they already agreed making the debt cheaper in real terms.
Up-skilling and Increasing Earnings
As Inflation leads to high living standards, an individual also needs to look for ways to increase their income so as to maintain the current living standards. This can be done by learning new skills, improving the already acquired skills, and investing in career development. This will increase the amount of income a person gets. Businesses also invest in innovations and product differentiation with the aim of being more competitive in the market, which leads to more revenue.
Participating in Inflation-protected Investments
Business and individuals need to invest in investments that are risk-free, like real estate assets and treasury. Inflation-protected securities are designed to directly or indirectly protect one from Inflation by appreciating during Inflation.
Conclusion
Inflation is an important aspect that needs to be considered when an individual and a business are making their decisions. Medium rate inflation can indicate a growth economy. Still, when the inflation rate is not controlled, it impacts the strategies of businesses and individuals, such as investment strategies, management of debt, spending behaviour, production strategies, compensation strategies and pricing strategies, which affect the normal operations of the business and an individual. Despite the impacts, one is able to mitigate them by implementing measures like investing in Inflation-resistant investments, spending on essential needs, applying for long-term fixed-interest loans and engaging in career development.
