The only debts you should be driven to pay off during high inflation are the variable interest ones. The others can end up being profitable if inflation is significantly higher than interest. Pay them down after other useful endeavors are scarce, or you have cash flow problems.
Don't pile on the credit card debt
It's a lot easier to reach for your credit card when prices soar. It hurts less than seeing your checking account balance erode. But racking up credit card debt during periods of high inflation is a double-whammy.
Regardless of financial situation, inflation impacts consumer debt, albeit indirectly. Lenders benefit when interest rates go up and the demand for credit increases, while consumers benefit by paying lenders back with money that is worth less than when it was borrowed.
The redistribution effect of inflation
Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out. Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed.
The middle class typically benefits from inflation because the middle class typically has a lot of debt. Think of someone who owes $100,000 on a $200,000 home. Inflation makes the home more valuable and the debt relatively less onerous.
Cash is there to serve mainly as your emergency reserves, to cover unexpected bills, as well as job loss. Once you have your short-term bases covered, experts recommend investing in assets that have a chance to offer you compounding growth.
Inflationary monetary shocks do the opposite: They hurt the most affluent more than the least affluent. This discrepancy is largely driven by the different response of asset prices: Monetary policy raises home and stock prices, which hurts those buying houses, while oil shocks do the opposite.
Prior research suggests that inflation hits low-income households hardest for several reasons. They spend more of their income on necessities such as food, gas and rent—categories with greater-than-average inflation rates—leaving few ways to reduce spending .
At low interest rates, this makes paying the mortgage off normally more attractive. The higher the inflation rate, the more this is true.) With the low-interest rate and 10% investment return, paying off your mortgage normally and investing significantly outperformed paying it off early and investing.
Common anti-inflation assets include gold, commodities, various real estate investments, and TIPS. Many people have looked to gold as an "alternative currency," particularly in countries where the native currency is losing value.
The Bottom Line. In modern times, the preferred method of controlling inflation is through contractionary monetary policies imposed by the nation's central bank. The alternative is a cap on prices, which don't have a great record of success. In either case, soft landings are hard to pull off.
Instead, focus on paying down variable rate loans (including credit cards). When rates increase rapidly, your minimum payment may only cover the interest without any money going toward the principal. Payments that go beyond the minimum amount can help you pay off debt faster.
Some of the worst investments during high inflation are retail, technology, and durable goods because spending in these areas tends to drop.
Key Takeaways
Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.
Consumers generally understand how inflation is bad for them: Everything costs more, and cash and savings lose value. But most people aren't aware that inflation can actually be a good thing in certain circumstances — namely, if you're in debt. The real value of debt decreases when inflation is high.
Detailed Solution
Debtors gain from inflation because they repay creditors with money that is worth, less in terms of purchasing power. And creditors lose the most, as they lend money when the value was high and get it back when it loses some of the value.
Right now, it's mostly losers. Inflation benefits those with fixed-rate, low-interest mortgages and some stock investors. Individuals and families on a fixed income, holding variable interest rate debt are hurt the most by inflation.
Higher prices often result in less cash flow and increased demand for credit. If more consumers need a loan or line of credit, lenders may get more business. However, some lenders may lose during periods of high inflation, especially if costs and interest rates continue to rise for months or years.
Inflation increases the cost of food and worsens food scarcity, increasing the likelihood that families will remain trapped in a cycle of poverty for generations.
$3,000 X 12 months = $36,000 per year. $36,000 / 6% dividend yield = $600,000. On the other hand, if you're more risk-averse and prefer a portfolio yielding 2%, you'd need to invest $1.8 million to reach the $3,000 per month target: $3,000 X 12 months = $36,000 per year.
How much is too much? The general rule is to have three to six months' worth of living expenses (rent, utilities, food, car payments, etc.)
Buy and hold. Investing in stocks, bonds, and Treasury bills is the best way to protect oneself from the effects of inflation in the long-term. The best strategy, regardless of how big the fluctuations can get, is to spread risk out by buying a “diversified portfolio” with many kinds of firms represented.