Inflation is spiking. Are your finances at risk?

Inflation is spiking. Are your finances at risk?

Prices are going up—inflation is back. Given the accelerating pace of inflation, Social Security announced that benefits will go up by 5.9 percent. That’s the biggest increase in more than two decades.

This might sound like good news, especially if you’re already getting a Social Security check.

Unfortunately, it’s actually neutral news at best. That’s because the increase in Social Security reflects rising prices in the economy. It might feel like a raise, but it’s just helping your retirement income keep pace with inflation. In addition, not everything is keeping up with inflation, so you might still lose purchasing power. (Of course, your PensionPlus paycheck automatically adjusts for inflation, just like Social Security.)

But wait—it gets worse.

One of the biggest dangers of inflation is that people fail to think about it when making financial decisions, which can lead to expensive mistakes.

To see if you’re at risk of making these inflation errors, please answer the three questions below.

The Questions

1)    If inflation continues at the current pace, and a gallon of milk costs $4.25 in 2021, how much would that milk cost in 20 years?

     a)     $5 [1 point]          

     b)     $7 [2 points]        

     c)      $9 [3 points]        

     d)     $13 [4 points]

2)    If inflation expectations increase by 1%, what is the likely impact on safe bonds, such as 10 and 30 year Treasury bonds?  

     a)     They will increase in value by 1% [1 point]          

     b)     They will fall in value by 1% [2 points]    

     c)      They will fall in value by 5% [3 points]    

     d)     They will fall in value by 20% [4 points]

3)    If inflation continues at the current pace, what is likely to happen to an adjustable rate mortgage?

     a)    It will get cheaper, with a lower interest rate [1 point]  

     b)    It will stay the same [2 points]    

     c)     It will get more expense, as interest rates rise  [3 points]


Many people consistently underestimate the impact of inflation, a mental tendency known as the money illusion.

Put simply, the money illusion refers to the fact that people tend to think in nominal dollars—the actual amount of money involved in a transaction—and not real dollars, which is the purchasing power of money after taking inflation into account.

The questions above are designed to measure your risk of engaging in the money illusion. The right answer is always “d,” or the highest amount.

It might seem strange to think of milk costing $13 a gallon, or a new truck costing $65,000, but that could be our future if prices keep rising.

To see how you did, add up your points. A score of less than 6 means you are at high risk. A score between 6 and 9 places you at medium risk and a score of 10 or above places you at low risk.

Here are four examples of how the money illusion can impact your finances in retirement, and the steps you can take to prevent unnecessary losses.

Investing: Many baby boomers have a large share of their portfolio in bonds. This is typically done because bonds are seen as low-risk investments. Alas, inflation can lead even the safest bonds, such as 10 and 30-year Treasury bonds, to fall in value by as much as 20%.

This is the power of inflation—it can turn seemingly safe investments into risky assets.

Refinance: If you’re seeing extremely low rates for adjustable rate mortgages, remember that these mortgages are likely to go up with inflation, and your payments could easily double in the future. This is because mortgages can rise faster than inflation. While a fixed rate mortgage might cost more initially, it won’t increase over time. What’s more, your fixed rate mortgage will actually become easier to pay with inflation, as your other sources of income (such as Social Security and PaceIt) will continue to rise.

Long-term Care Insurance: Most long-term care insurance plans pay a maximum daily amount, set somewhere between $50 and $550 dollars. However, if you choose to buy a long-term care insurance plan in advance, you should be sure to take inflation into account. (Many long-term care plans offer an optional inflation protection feature.) Given inflation, even $550 per day might not buy you the help you need. For instance, if you claim your long-term care plan in ten years, that $550 maximum daily amount would only buy $293 worth of medical care, given current inflation rates. You might have to get by with half a day of help, instead of the full day you need.


1)    If you got all the answers right, you’re probably taking inflation into account when making financial decisions. Keep up the good work.

2)    If you’re at moderate risk, it’s especially important to focus on inflation when making long-term choices, as that’s when the money illusion can have the costliest consequences.

3)    If you’re at high risk, think carefully about inflation when making all of your financial decisions. And don’t be afraid to ask questions, whether it’s asking an insurance agent how inflation might impact your long-term care coverage or asking your mortgage broker how your payments would change if inflation goes even higher. This is complicated stuff – there are no bad questions.

Additional reading: Shafir, Eldar, Peter Diamond, and Amos Tversky. "Money illusion." The Quarterly Journal of Economics 112.2 (1997): 341-374.