Recently I spoke at the Salone di Risparmio about inflation and more importantly how financial advisors can help clients better understand and plan for the financial issues it can cause. If you weren’t able to attend, I wanted to provide some highlights that could be used with clients no matter the age.

Inflation affects us in many ways. The main way we feel it is on a day-to-day basis when we go to the supermarket or gas station. Over the past couple of years, gas prices have increased by 15%ⁱ and the cost of groceries and unprocessed foods have increased by 6.7% on an annual basis.ⁱⁱ This is painful for consumers and clients, who are in effect losing money due to inflation.

It’s important for financial professionals to understand that these losses can cause clients to make emotional (and often bad) decisions. For example, it could lead them to sell their “risky” assets and put those proceeds into cash. This defies logic, as the rational thing to do when prices are rising is to seek investments that have the potential to grow at rate that can outpace inflation. While that may be the case, we also know that humans don’t always behave rationally.

We have seen this irrationality play out around the world as investors have increased the amount of money they have in cash, money market funds or liquidity stocks.

So how can we help our clients understand that they must stay invested in order to continue building toward their future savings goals? One approach is to illustrate the point using historical data, such as the chart below showing how savings can be eroded by inflation over time.

That’s why I think it’s important to help clients think about the impact of inflation in different ways. That could mean asking to your client to think of themselves as a business and reminding them that running a profitable business means saving and growing your overall net worth at a pace that exceeds your input costs. Over time, if you have to pay more for the materials used to make your products, then you will eventually need to increase the price of your product. Your client can apply this same basic thinking to their personal finances, but in this case, the product is their investments and savings, and the input cost is inflation. The higher inflation goes, the more they need to save and the more those savings need to grow.

Reminding clients that many people are conservative, risk averse and hold assets in cash – and backing it up with research – will help them feel heard. And if they understand their emotions are shared by others, the hope is that they will say, “If that’s the case, what should I do next?”

From there, we can follow some simple but important financial planning steps.

1. Set Goals – Simply making sure clients think fully and deeply about – and then write down – their goals can help decrease stress.

2. Create a Plan – The importance of this step in helping clients cope with stress can also be backed up by research: 75% of investors who do not have a plan report experiencing high levels of negative stress.^v Not only does creating a plan help set a course, but it also allows you to review the client’s goals based on future changes in the market, expenses, health, taxes – and yes, inflation. Plus, going through this process can help clients reduce negative stress. And with lower negative stress, they will be more likely to stick to the plan.

3. The Importance of Liquidity – Research has found that liquid wealth or cash had a higher correlation to perceived wellbeing than total investments, spending income or indebtedness. Even when interest rates are low, cash plays an important role in asset allocation during changing market and economic conditions, including what we’re going through right now. Using a bucketing approach, for example, allows us to keep the majority of assets invested in the market but also have a small portion of cash on hand. That small portion of cash helps clients meet expenses, but more importantly it can provide an emotional check against bad decisions.

4. Start small – Remember, we’re dealing with investors who may be risk averse, stressed out and emotional based on what’s going on in the markets. Because of that, I think a PAC (pre-authorized contribution plan) can be an incredible tool for investors, both young and old.

People may be hesitant to invest in general, and the idea of investing 10,000 euros all at once may be incredibly scary. A PAC allows investors to start small but have less money at risk, which can help lessen those feelings of loss aversion One of the other reasons I like this type of arrangement is that it helps individuals create a financial habit. What’s more, that financial habit of consistently investing a certain every month can help smooth out the impact of volatility over time and potentially outpace inflation.

The financial impact of inflation provides us with a view of how the loss of money can affect investors emotionally. It also provides us with an opportunity to let our clients be heard and to remind them that long-term financial goals can only be reached through long-term planning – not short-term emotions.

Key takeaways

Key takeaways