Written by Kyle J Christensen, CFP, Nov. 9, 2022
Inflation has been one of the top concerns on people’s minds lately, as well it should be. How does inflation affect us financially? Most people can easily see how inflation impacts the dollars in their wallets. They are worth less. I’ve heard estimates that inflation has basically taken away about $4-5,000 in purchasing power from the average family in the United States over the past year. Gas prices have hit new record highs, food prices have skyrocketed, home prices have reached the stratosphere. So, the impact on money in our pockets has been very apparent.
What about other aspects of a person’s finances? How has inflation affected those? Well, if a person was following the traditional planning method and thought they needed a certain amount of money in order to retire, suddenly that number became way too low. Let’s say they were being told by their financial planner that they needed $2,500,000 in their “nest egg” in order to retire, after inflation of 8% for just the past twelve months, that value has dropped to $2,315,000 in purchasing power. Now the client needs $2,700,000 to feel the same as $2,500,000 would have if inflation had not occurred at the rate it has. If inflation continues at a higher rate than normal for the next ten years, the amount a person thought they needed, versus what they actually will need, is nowhere near the same amount. At an inflation rate of 5% over the next ten years, a person would need $4,072,236 to have the same purchasing power as $2,500,000 does today, ten years from now. Needless to say, inflation is a very big deal, and can be a very big problem in personal finances.
One area of personal finances that I believe few people are aware inflation is having a major impact is in the protection area of their plans. Let’s start with auto insurance. If you have Property Damage Liability Protection on your auto insurance (which you do, if you have auto insurance), you may want to make sure it’s still sufficient. Why? Because the price of vehicles has grown tremendously over the past few years. The average price of a new vehicle today is $46,000, according to an article citing Edmunds.com. According to the same article, the U.S. Bureau of Labor Statistics said recently that used car prices have increased by 40.5% from Jan. 2021 to Jan. 2022. What level of coverage do most people have on their Property Damage Liability? I usually see $50,000 or less when I meet with people. The inflation that we are seeing means that Property Damage Liability limits of $50,000 or less are probably too low and should be raised to at least $100,000. Coverages like these don’t change automatically. So, if you aren’t paying attention and know that you need to make the changes yourself, you might find out the hard way (after an accident occurs – which is the worst time to find out). Your Property Damage Liability may need to be raised even higher than that in the very near future, especially if the rate of inflation we’ve had continues. If the purpose of auto insurance is to protect you (your income and your assets) from unexpected liabilities, but you don’t have sufficient coverage to do that job, then you need to make a change, or I guess be happy with the likelihood that you will be forced to come out of pocket for the rest (sort of defeats the purpose of having auto insurance in the first place though).
This questioning of whether or not our levels of protection are enough or not is something we should consider throughout the protection area of our finances.
I want to focus on one more specific area of protection before I end this article, and that is life insurance. I see how people usually make their life insurance decisions, and it’s generally not good. First, life insurance is misnamed and misunderstood. It should not have been called life insurance. It should have been called income and asset insurance. Nobody has a question as to the purpose of homeowners insurance, because it was appropriately named. Also, because people know what homeowners insurance is supposed to do, they usually have adequate coverage on their policy. Additionally, unlike life insurance, the Dwelling Coverage on homeowners insurance automatically increases every year, so that it can account for the increasing cost to rebuild a home. However, one caution, especially in high inflationary periods, the automatic increase may not be sufficient.
Back to life insurance, which should have been named “income and asset insurance”. Let’s say you picked a “nice round number” for your life insurance coverage in the past. Let’s say $1,000,000. It probably sounded like a decent (or even a lot) of money at the time when you got it. You may have even said to yourself, “My surviving spouse is young, attractive, smart, and could easily get remarried or get a job or increase income if I were to pass away.” First off, all of those responses are actually terrible. I’m not saying that it’s bad that you think nice things about your spouse. I am saying that it’s terrible that you would try to predict the future and limit what you would provide your surviving spouse based on those things. Inflation makes all of that a whole lot worse! That $1,000,000 is not worth nearly what it was even a year ago. Five years from now, it’s going to be worth significantly less. It eventually becomes a piece of chewing gum that you are sticking into the growing holes in a dam. Pretty worthless.
How can or should we deal with this then? What’s a better way to make decisions on your life insurance? I like to refer back to our principles, and in particular, Principle #2, which is Maximum Protection. If you aren’t trying to predict the future, and can admit that you actually aren’t capable of predicting the future, then following the principle of Maximum Protection makes a lot of sense. Maximum means getting the most you can. You might think “I don’t want to be ‘insurance poor’.” The good news is, you can’t. The life insurance companies won’t sell you unlimited amounts of life insurance coverage. There is a maximum. A limit that you can purchase. Whether that’s sufficient or not, who knows? Is it going to be the best you could do regardless of inflation? Yes! Isn’t that the real purpose of protection, to do the best you can do?
The high inflation that we’ve been experiencing has only reinforced to me that everyone should find out what their maximum life insurance is, and get it. Don’t try to predict what the future will be like. You can’t predict it. Neither can I. By getting your maximum, you are simply putting yourself and your surviving spouse (if you are married) in the best position you can be in.
If anyone tells you you don’t need your maximum life insurance, please ask them to write down their recommendation and sign and date it. Now they are your insurance, especially if the person telling you not to get your maximum is an insurance licensed agent.
Always remember the “first rule of insurance” (ref Who Took My Money, by Robert Kiyosaki), which is that you can only get insurance when you don’t need it. So, don’t wait until you know you need it. By then, it’s too late.
Inflation is a major problem and it affects your protection as much as it does your savings and investments. By having your Maximum Protection, you are minimizing the negative impact of inflation on that oft-overlooked area of your plan.