Inflation is one of those financial building blocks that seldom gets the light of the day when it comes to money management, and it silently (and often negatively) affects your wealth-building. Inflation whispers into your pocket: It may take years to fully feel the diminishing value of your blood, sweat, and tears even if you are saving really well.
So what is inflation in the first place? How will it influence your money in the bank? But what is the dynamism there, and above all, how do you protect your money from devaluation? In this guide, we will break down inflation in the simplest terms, and offer realistic steps you can take to prepare your future finances.
What Is Inflation?
The simplest way to define inflation is, it is how much the price of products and services rises over time. The value of money declines as inflation increases – so more money buys you less and less goods over time.
Consider what the price of a cup of coffee is today, say $2. In other words, that same cup could go for $2.06 next year if inflation continues to climb 3% each year. Although a few cents here and there might not seem like much, this gradual upward trend can cause the cost of living to increase noticeably over time.
Inflation can be defined using CPI, which tracks the average change over time in the prices paid by consumers for a market basket of consumer goods and services — including items such as food, clothing, and rent.
💡 Why Does Inflation Happen?
While there are many reasons why inflation can happen, the most common are:
Demand-Pull Inflation: In a case where consumers demand more goods and services than what the economy can provide, it leads to rise in the prices. That typically occurs in an expanding economy.
Cost-Push Inflation — This occurs when the expenses of manufacturing goods go up (for example, higher wages or costs for raw-materials) and in response firms hike prices to get back those costs.
Cost-Push Inflation: As workers demand higher wages to keep up with rising costs, businesses often pass those wage increases on to consumers in the form of higher prices.
How Inflation Limits the Value of Your Savings Over Time
A lot of individuals view saving money in a traditional savings account as adequate for the future. But over the long run, inflate makes those savings worth less and less real value. Here’s how:
1. Reduces Purchasing Power
People inevitably experience one of the most prominent effects of inflation: the reclamation of purchasing power. That money might seem safe or untouched in your balance, but you quickly lose value in it as prices go up.
Example:
In effect, if you save $1,000 today, with a 3% inflation rate, in five years, that $1,000 will only buy the amount of goods and services that $860 would buy today. This means however that you will be able to get less for the same amount of money.
2. Devalues Cash Savings
A regular savings account may be the safest option when it comes to keeping your money secure, but if the rate of interest on your savings is less than the rate of inflation, then you are losing money.
Example:
Assuming a 1% interest rate in your savings account and a 3% inflation rate, your money is effectively losing its value by 2% every year.
3. Affects Fixed-Income Investments
Inflation is one of the most damaging forces to investments that get a fixed rate of return like bonds or CDs. In the event that inflation rates exceed what is gained from interest, the actual profits become diminished.
Example:
You might have a bond paying you 2% a year, but if inflation is 4%, you are losing purchasing power, even if your investment technically is earning interest.
4. Increases Cost of Living
When inflation, the price of necessities — the price of food, the price of rent, the price of health care — also increase Failure to beat inflation can also mean that your savings might not grow fast enough to afford necessities in the future.
💪 How to Save Your Money from Inflation
Inflation is unavoidable, but there are ways to make it less harmful to your savings. To protect your money, try out these simple and effective methods:
1. Put Your Money into Things That are Not Affected by Inflation
You can keep your wealth intact by investing in frank assets that historically beat inflation. The best solutions — some of them are:
2. Stock: On average, stocks will outperform inflation over the long term.
Real estate — which will usually increase in value along with inflation, and a steady stream of rental income can follow.
3. Commodities — During the inflationary periods, Gold, silver, and oil tend to hold their value.
Investment Guarantees Against Declining Inflation — In the United States these are treasury inflation protected securities (TIPS) which guarantees you investment value against inflation.
4. A High-Yield Savings Account
To keep your nest egg in the bank, search for a high-yield savings or money market account. These accounts provide higher interest rates than traditional savings accounts contributing towards an increased growth of money and defeating inflation.
5. Diversify Your Investments
Avoid concentrating your funds in a single investment vehicle. Investing in a variety of assets in a portfolio, including stocks (or index funds), bonds, real estate, and even leveraged real estate (apart from mutual funds) can help prevent your wealth from being devalued by the effects of inflation, even if it is a bit more difficult in practice.
6. Increase Your Income
You can fight inflation by making more money. It could be anything from a raise, doing a side hustle, or going back to school to increase your chances of success. A bigger paycheck can help make up for the higher cost of living.
7. Reduce Avoidable Expenses
Check your budget frequently and drop expenses that do not need to be there. And, the more you save, the more you can invest your surplus dollars into assets that will insulate your dollars from inflation over time.
8. Keep An Eye On Inflation Rates
Staying on top of inflation dynamics can assist you in better planning your financial decisions. As inflation increases, you can adapt your savings plans, or potentially move your allocations to things that are resistant to inflation.
How Compound Interest Beats Inflation — 📊 Compound Interest vs Inflation
Inflation might eat away your money, but compound interest can help you fight back. When you earn interest on your investments and that interest is reinvested (the so-called interest on interest), it can really add up.
Example:
Assume you open an account that contains $1,000 and it earns a 5% annual return. In one year, you will receive: $1,050. The second year, you are now earning on $1,000 and the additional $50. Eventually, if you keep investing in inflation-beating asset returns, this compounding impact can surpass inflation.
Inflation and Savings FAQs: Your Questions Answered 🧐
Is Inflation Good For the Economy?
Yes, moderate inflation is usually a sign an economy that is healthy and growing. It prompts consumption and investment, which stimulates the economy. But he said the numbers are very worrying, with high inflation doing more than damage to savings and living expenses.
How to work out how much inflation is costing you on your savings?
Utilizing an online inflation calculator, you can see how the value of your money will change over time based on the inflation rate today.
Does Inflation Impact Retirement Savings?
Is it true that inflation devalues retirement savings over time? To keep your purchasing power in retirement, you have to invest in assets that are beating Inflation over the long-term.
How often does the inflation rate change?
Inflation ranges change regularly, often every month or yr, counting on financial conditions and authorities policies.
Fixed-Rate Loans — Can They Save You During Inflation?
During high inflation, fixed-rate loans are advantageous because your repayments remain the same even as the value of money declines over time.
Key Takeaway: Protect Your Savings from Inflation
Inflation is a quiet killer that can slowly eat away at your savings. But appreciate the way inflation functions, there are proactive way so that your wealth is protected, and your money still can grow over time.
But if you invest smart, diversify your holdings and monitor inflation trends, you can stay ahead of the game and protect your economic security. Get started today — you will thank your future self! 💡
Want some direction on what inflation-proof investments you can consider as a beginner?
Jamie
