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.
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. If you carry a balance on high-rate credit cards, try to transfer it to a zero-percentage-rate card and pay down the debt as soon as possible.
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.”
Most financial experts recommend consumers have a rainy day fund of three to six months 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 mind-set may be a challenge for some spenders.
“It’s a huge culture shift,” Greenwood says.
But for many people, the process is under way already. Consumers are being more cautious as a result of the drop in the financial markets and heightened fears of a deep recession.
Holding tighter to your wallet now actually can pay off later. For example, financial planner Francis says, people who spent less during the holiday season are likely to reap the benefits of sales in the first part of the new year.
“There are going to be unbelievable deals to be had,” she says.
Getting a firm grip on your financial situation can help ease fears that rear up when headlines turn unrelentingly bleak.
“There’s not a lot that we can control, but we can control what we spend,” says Francis.
Most financial experts advise consumers to draw up a budget if they don’t already have one. This reveals where spending is going and helps consumers make adjustments.
If you don’t like budgets, there are other ways to get your finances on track.
Save for specific financial goals by setting up automated transfers from your main bank account to a second account. Money in the second account can be earmarked for specific goals, such as college funds for your children, a retirement nest egg or vacation money.
Software — such as Microsoft Money and Quicken — and online sites such as Mint.com can help you track where money goes. These tools tie together your accounts and offer a clear picture of your financial bottom line.
“Even those individuals who have the most plush emergency-fund cushions underneath them … are looking at their everyday expenses using these great online resources to give themselves a little bit more wiggle room and a feeling of financial security,” Francis says.
Deflation can take a toll on jobs. Should your employer need to make cutbacks, you’ll want to be last in line.
Try to make yourself indispensable at work. Don’t show up late. Be on top of things.
“Make sure that your employer knows that your talents are definitely needed,” finance professor Cherin says.
What’s more, keep your eyes open for opportunities elsewhere. If your job is eliminated, you’ll want to have another place to go to help make a smoother transition.
Start renewing your network by meeting with former colleagues and other contacts for lunch or coffee. Join social networking sites such as LinkedIn or Facebook, which can help you stay in touch with people.
Refreshing your network can help you keep an ear to the ground for job openings, as well as keep you current about areas in your industry likely to grow.
Consumers who have secure jobs, emergency funds set aside and sound financial plans may find that a deflationary economy is a great place to scoop up bargains.
Falling prices already are creating opportunities. Some first-time homebuyers are finding homes selling for 25 percent less than sellers were asking a year ago.
People beginning to build an investment portfolio now have a chance to buy stocks of solid companies at bargain basement prices.
Deflation also can offer opportunities to save on smaller purchases. For example, travelers may find trips offered at big discounts.
“During the Great Depression, there were a lot of millionaires created. These were people who took advantage of the opportunities that were in front of them,” says Doug Lockwood, a Certified Financial Planner at Cornerstone Wealth Management, a consulting firm in Auburn, Ind.
By investing in assets when prices are low, consumers can use an episode of deflation as a rare opportunity to build wealth, Lockwood says.
“Ten years from now, we’ll have a large number of people sitting back and saying, ‘I wish I would have,’ or ‘I wish I could have,’ and they’re going to be talking about right now,” he says.