Five Ways to Outlast Deflation
Deflation is a word on the lips of more financial experts these days.
The term refers to a fall in prices (despite no change in product quality or quantity) and is the opposite of inflation. But like inflation, deflation can have a devastating impact on individual pocketbooks and the broader economy.
On the surface, deflation sounds great. Most consumers cheer when gas prices fall or housing becomes more affordable.
But deflation can be too much of a good thing.
"It would be a wonderful deal, except as prices fall on various things, pretty soon the price that is demanded is not enough to pay workers who build the television sets or whatever it may be. Then they get laid off," says Tony Cherin, professor emeritus of finance at San Diego State University.
Such job losses make consumers nervous and less likely to spend, deepening the downward trend.
Most financial experts say the odds of the U.S. entering a serious deflationary spiral are low but not outside the realm of possibility.
"I think we're flirting with it, and I think there are risks that we have to be careful of," says Stacy Francis, president of Francis Financial Inc., a fee-only financial planning firm in New York.
There are several steps that consumers can take now to prepare themselves to survive a deflationary cycle. In fact, a little preparation may help you to actually benefit from downward price pressure.
Following are five tips to help you survive -- and even profit from -- deflation.
Deflating deflation
Here are five ways to survive -- and even thrive -- in a deflationary economy.
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Savings and Investing Advice and Tools from Bankrate.com:
- Creating an Emergency Fund
- Bankrate Savings Calculator
- How to Develop a Savings Plan
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1. Get rid of old and new debt
In a deflationary economy, dollars are worth more going forward. That's because falling prices allow each dollar to buy more in the future.
People worried about deflation want to avoid debt because deflation would make paying off a loan even more expensive.
For example, in a deflationary economy, a computer that sells for $1,000 today might carry a price tag of $990 next year. Or, if you buy a car for $20,000 today, you might be able to buy a better car for $20,000 next year.
However, while prices in a deflationary economy go down, the amount of your loan does not.
"It's painful. If you're worried about this, get out of debt as quickly as you can," says Dan Greenwood, a law professor specializing in corporate finance at Hofstra University School of Law in Hempstead, N.Y.
Consumers can take many different steps to lessen their debt burden quickly. Ridding yourself of debt can go a long way toward alleviating your financial fears during a deflationary economy.
"If you're impacted by the economy, the last thing you want is to already have a negative balance sheet in your name," Francis says. "You don't want to have huge amounts of credit card debt, since it only puts more stress and anxiety on you."
2. Build emergency savings
Most financial experts recommend consumers have a rainy day fund of three to six months' worth of living expenses in cash tucked away for emergencies, such as a sudden job loss.
With unemployment rising, some advisers are raising that target to six to nine months.
Switching to a saver's mindset may be a challenge for some spenders.
"It's a huge culture shift," Greenwood says.