Retirement

Good Debt Versus Bad Debt And Ways You Can Benefit From Inflation

With inflation remaining aggravatingly high, it’s easy to assume this works against you in all parts of life.

But there are some ways that it can actually improve your net worth and financial flexibility when you’re self-employed – and in ways that you might not consider.

With rising costs, come tightened budgets for many Americans. You certainly see this as credit card borrowing increases and the amount spent to reduce credit card balances falls. According to a recent Federal Reserve Bank of New York study, total credit card debt has reached record highs while more than one-in-four say they’re allocating less money towards repaying debt than they did in 2022.

That’s a scary combination, as you’re borrowing more and paying down the debt less. And it’s difficult in many situations, where paying the grocery bills becomes ever more difficult. But for those with robust self-employment businesses, there are certain ways that inflation actually increases your overall net worth and potential for ongoing wealth gains.

Understanding the benefits of these now can help you if costs continue to rise – or better position your finances as you grow in your business.

Fixed debt costs fall

The danger of credit card debt is that it comes with very high interest rates, and those rates can even rise as interest rates increase as well. It’s the same concern for those with a variable interest rate on their home.

But in times of rising inflation, you do see an advantage if you have fixed rate debt, like a fixed-rate mortgage.

Finance researchers at the University of Chicago Booth School of Business and the Goethe University evaluated the impact of higher rates on lenders to a German bank in July 2022. At the time, the inflation rate of 8.7% was the highest the country had experienced in 70 years. What they found was that those with fixed rate debts didn’t understand that as inflation rises, it actually reduces the impact of the fixed rate debt.

It’s the opposite experience if you’re saving in a fixed rate instrument, for example, which would reduce your gains in a heightened inflation environment.

In fixed rate debt, you’re paying the same amount for the debt, but everything else rises. In essence, you gain because your debt is cheaper compared to the market – and hopefully your income grows as well.

Those that were educated on this dynamic were more willing to spend, according to the study’s results.

The ability to increase prices

Part of the reason people may not capture the dynamic of fixed rate costs is because their income doesn’t directly rise with inflation. That’s true for most employees since they cannot always dictate raises. While wage increases have outpaced inflation recently, it takes time for the dynamic to unfold.

But those running private practice businesses or self-employed operations can implement price increases that rise with inflation.

By doing so, they capture similar income overall, while also reducing the impact of fixed-rate debt. This, of course, comes with caveats since you can only raise prices at the rate your individual business dynamics allows. And if customers, en masse, reject the raises, then that can become a problem.

But for the service-based self-employed, simply incorporating cost of living adjustments to contracts and services will allow you to easily incorporate the idea that your rates rise with inflation. In doing so, your purchasing power remains strong while the potential for your overall expense exposure to decline (if you have fixed rate borrowing in place). Meanwhile, it becomes ingrained in the customer experience.

Encourages a second eye on expenses

It’s easy to let your expenses grow as your business expands. But sometimes it requires taking a second look at those expenses, to ensure a reduction.

With inflation remaining higher than expectations over the past couple of years, it’s probably a good time to return to the expense line and reevaluate ways to reduce.

It’s important to keep expenses that are required for you to operate. But looking to cut in areas that do not provide you with additional income or repricing tools and software that you have used for a couple years can lead to drastic cuts to your expenses.

In doing so, you can reduce that monthly cost – especially if it seems to be growing faster than your income. It also allows you to evaluate where to invest next (and what to avoid).

If inflation continues forward, it’s steps like these that will allow you to profit long-term.

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