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Inflation has been getting out of control in recent months, setting 40-year records in the wake of the pandemic and the worsening energy crisis caused by the Russia-Ukraine conflict. Now, more than ever, it is important to understand inflation, why it’s bad, and how to handle your money as a teenager in an inflationary period.

The Summary: 

• Inflation is a measure of the change in purchasing power of money over time
• Moderate inflation (around 2.5%) incentivizes spending and keeps the economy active
• High inflation erodes the purchasing power of consumers and negatively impacts both individuals and the economy
• Inflation is controlled by the Federal Reserve and the US government
• Investing in assets is the best way to protect your money against inflation 

What is inflation? 

Inaction is a measure of the change in purchasing power of money. In other words, inflation means money is worth less over time, whereas deflation means money is worth more. In the United States, inflation is measured by the Consumer Price Index (CPI), data that measures the price changes of a basket of goods like housing, food, and furniture. CPI is collected by The Bureau of Labor Statistics and published every month in a report that breaks down the inflation of specific goods/services. 

But really, why does inflation happen? Almost everyone knows why you can’t just print money to solve poverty because of inflation. But most people don’t actually understand why. 

Suppose there are only a finite number of goods produced, say 100 apples per day, and a limited amount of money being printed, say 100 dollars a day. Each day, the 100 people in the economy use their one dollar to buy an apple. Since apples are the only product in the economy, an apple might cost 1 dollar. Let’s now say the apple government decided to print 25 more dollars each. Whoever gets those 25 dollars can’t just go and buy an apple because there are only 100 apples. The apple sellers will notice this and adjust their prices to start charging more for apples.

As you can see, printing money does not create more value; it just means that the purchasing power of the currency (how much the currency can buy) will fall.

Is inflation bad? 

The economy revolves around one thing in particular: the total value of money spent by individuals on final goods and services, known as consumer spending. Simply put, mainstream modern economists believe that low and stable inflation of around 2.5% has economic benefits. It incentivizes consumers to spend money because the value of their dollars is slowly decreasing. However, they are still confident in the stability of the currency. 

A low inflation rate also makes taking on debt more attractive for individuals, businesses, and the government.  

“If wages increase with inflation, and if the borrower already owed money before the inflation occurred, the inflation benefits the borrower. This is because the borrower still owes the same amount of money, but now they have more money in their paycheck to pay off the debt. This results in less interest for the lender if the borrower uses the extra money to pay off their debt early.” – Investopedia.  

That means that inflation can help effectively reduce the real interest rate (interest rate accounting for inflation) of a loan. 

Any deflation is seen as bad because it disincentivizes consumers to spend, which slows down the economy. The thought process goes, “Why spend your money now when it will be worth more in the future?” This creates an economic slowdown that can spiral out of control. 

SLIGHT inflation at (around 2 – 2.5 percent), on the other hand, is seen as good. This encourages consumers to spend money but not to panic because their money isn’t rapidly losing value.

You may have heard of examples like Zimbabwe, which experienced three-digit hyperinflation. This is probably the worst thing that can happen to an economy. Money soon becomes almost valueless, the economy and financial institutions come crashing down, and citizens lose trust in their government. Luckily, the 8-9 percent inflation we are experiencing now is nowhere near that threat. 

Unfortunately, due to a combination of factors like COVID-19, the Russian invasion of Ukraine, and tremendous levels of new money from stimulus efforts, the dollar has seen shocking inflation that hasn’t been seen in 40 years. This sounds bad… and it is… but many other countries are experiencing worse inflation right now. For example, the Euro, which is the predominant currency in the European Union, is rapidly losing value compared to the dollar. Since the Euro’s peak, it has lost 35 percent of its value compared to the dollar and, for the first time ever, is worth less than the dollar. 

But just because we aren’t facing the worst inflation doesn’t mean you shouldn’t think about how to protect your money against it. Unless you want your money to steadily lose value, you should consider how to handle an inflationary macroeconomic environment.

What controls inflation?

Economies are very complex, and there are many factors that influence the inflation rate. Beyond those economic factors that can’t be controlled, there are ways that inflation is kept in check. There are two main methods that control the controllable inflation factors. In the United States, we have a central bank known as the federal reserve. 

“The Federal Reserve (the Fed) enjoys a unique public/private structure that operates within the government, but is still relatively independent of government to isolate the Fed from day-to-day political pressures in fulfilling its varying roles” Federal Reserve Bank of San Fransico. 

The fed controls monetary policy, which is defined by Investopedia as “Monetary policy is a set of tools used by a nation’s central bank to control the overall money supply and promote economic growth and employ strategies such as revising interest rates and changing bank reserve requirements.” 

These are important factors in the inflation rate, so the federal reserve has a lot of power over the inflation rate and tries to keep it in check. Spoiler alert: that doesn’t always happen. 

The other body that has substantial control over inflation is the government. 

“Fiscal policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty.” – IMF. 

Through decreased spending and increased taxation, the government can slow the economy and reduce inflation. 

The inflation tax 

So you might still be asking, “why does this matter to me?” Well, holding cash when inflation is high (or even low, for that matter) leads to your money being worth less. You could say it’s like an inflation tax. 

According to economicshelp.com, An inflation tax is defined as follows:  “Inflation tax is an implicit tax on nominal assets, such as cash, bonds and saving accounts. Inflation reduces the value of money and therefore reduces the real income of households.”

So how can you avoid paying the inflation tax? Well, you need to invest in assets that appreciate in value to counteract inflation from corroding your money. You could invest in stocks, real estate, collector items, cryptocurrency, or anything else that has a history of being worth more and more each year. We will dive into the specifics of how to invest as a teenager in the next section. 

How to fight inflation by investing as a teenager: 

There are dozens of different assets you can invest in, but unfortunately, as a teenager, your options are a bit more limited. Investing in stock is by far the easiest for teenagers and allows you to still get exposure to many different asset classes. In this section, I will briefly outline how to invest as a teenager. If you want a more in-depth explanation, click here to read the whole article about investing for teenagers. 

As a minor (someone under the age of 18), you’ll have to open a specific account called a UGMA account, more commonly known as a custodial investment account.

“The term custodial account generally refers to a savings account at a financial institution, mutual fund company, or brokerage firm that an adult controls for a minor (a person under the age of 18 or 21 years, depending on the laws of the state of residence). Approval from the custodian is mandatory for the account to conduct transactions, such as buying or selling securities.” – investapida.com

Even though you can’t invest by yourself as a teenager, you can still buy, own, and sell stocks as long as your transactions are approved by the parent or guardian (custodian) you open your custodial account with.  

Now that you understand how to invest, you also have to understand what stocks to buy. This is a skill that takes years to perfect but will help you build your wealth and protect against inflation for the rest of your life.

Understanding how to evaluate which stocks to invest in is a skill that takes a long time to develop, but there are a few important things to do before investing in a company:

• Research the company so that you understand them
• Consider the company’s growth opportunities 
• Make sure the company has an advantage over its competitors
• Evaluate what the risks are to a company’s success
• Think about investing in index funds and ETFs to easily diversify
• You can read my full article about evaluating stocks here!

After opening a custodial account and considering these points, you are ready to begin investing and protecting your money against inflation!