All of the talk is about inflation. Gas prices are up. Food prices are up. Interest rates are climbing, and the government is going to pass a $1.9 trillion spending bill. This will be the largest spending bill in American history. The Federal Reserve is suggesting we need to keep rates low for longer and that they can tolerate an extended period of above average inflation. The good news is the economy ─ and the markets─ will enjoy this feast in the short term. Unemployment will continue to drop, incomes will creep up, and everything will feel great during this party! That is, until inflation takes off.

Inflation: The Economic Hangover

Inflation is the hangover that overstays its welcome. Taxes will likely go up to help pay for the spending bill as well as the next spending bill that will address infrastructure. Interest rates will likely rise as well, which will increase the amount needed to service the $28 trillion in federal debt, which will lead to higher taxes again. For those who think the Federal Reserve can just shut the inflation off when they want to, I ask you to think again. The last time they did that was under Paul Volcker. Mr. Volcker did a heroic thing in raising interest rates to the point of outright pain. It was an unpopular action that was necessary to rescue the purchasing power of the dollar.

Dead Reckoning: The Rate of Change

It is well known that there are a number of asset classes that have the potential to do well in an inflationary environment. These investments include gold, TIPS (Treasury Inflation Protected Securities), and there is speculation that bitcoin might have that characteristic as well. These investments are probably a good idea, but how do you monitor the effect of inflation on your purchasing power? One of the first elements of a financial plan is a budget. Please don’t yawn. I know building budgets is a boring exercise. I know you will forget something that makes the exercise useless. I will not ask you to build a budget. Instead, I am going to introduce you to “dead reckoning.” A budget is a snapshot in time, nothing more. Dead reckoning measures the rate of change which is far more relevant during inflationary periods of time.

The term “dead reckoning” is a sailing term that is short for deduced reckoning. If I have sailed between two points on a regular basis, I have an idea of how long it will take me to get from point A to point B under normal circumstances. If I have a tailwind, I can use dead reckoning to assume I will reach point B faster than normal. With enough practice, I can become fairly accurate at my guesstimates. If the seas are extremely rough that day, I have to assume my vessel will move slower than in calm waters. The Dynamic Map method of financial planning (created by Mike Helgesen) uses dead reckoning instead of budgeting for two reasons. First, it is fast. The first time you do it will probably take about twenty minutes. Each month after that will take about three minutes. Second, it is NOT a snapshot in time. It is dynamic and measures the rate of change which helps you manage your cash flow better during inflationary environments.

The first step is the easiest. Identify how much income you receive from all sources. Almost everyone is aware of how much income they receive. If you have earned income from your employment, rental income from real estate you own, or income from investments that you use for spending, please add all of these up. Most Americans spend the income they earn, with the exception of the small amount that is set aside for their long-term investments. Add up the amounts that were spent in your variable accounts (checking account, credit cards, or brokerage account if you use that to pay bills) and subtract the total from your total income. This becomes your benchmark. For example, let’s assume I have a total of $10,000 this month in income. All of my bills are paid from my checking account and I have some debt on a credit card. The total for this month in expenses from each is $9200. However, I did contribute $1000 to my investment portfolio, which means I am running a deficit of $200. At first glance, I might feel like I need to panic. However, this is just one month.

Easier Over Time

Although it might sound like this could become a tedious exercise each month, just the opposite is true. Rather than counting each expenditure, you simply need to monitor the change in the balance of these accounts. If the checking account is constantly being drained and the credit card balance continues to rise, then you know you have a problem which requires your attention. If the checking account runs dry but the credit card balance is just moving slightly up and down from month to month, your rate of spending is actually in check. The biggest advantage to this method is it is agnostic towards who spent the money and how. Frequently, this conversation leads to fights because one spouse spends too much on things the other spouse is not aware of or doesn’t care about. Dead reckoning will only initiate that tough conversation if the spending spirals out of control.

Although we are not seeing runaway inflation at this point in time, we need to be prepared for what could show up next year. All of the necessary elements are there. It is up to each of us to enjoy the party but purchase the meds for the hangover that could be coming soon.

Jeff Mount is President of Real Intelligence LLC.  Jeff has been active in the financial services business for the last 25 years.

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