A simple definition of inflation is that it’s the increase in the cost of goods and services over a time period in an economy, which is usually expressed as a yearly percentage. Inflation rates are measured by price indexes, including the consumer price index by the Bureau of Labor Statistics and the personal consumption expenditures price index from the Bureau of Economic Analysis.
So how does inflation affect your money?
Inflation erodes the purchasing power of your money over time. As prices rise across the economy, your money can buy fewer goods and services than it could before.
Here are Some key ways inflation impacts your money:
- It reduces the real value of your savings and cash holdings, as the interest earned is often lower than the inflation rate.
Having savings and investments may not necessarily mean that your money is growing, especially when the interest rate is lower than the inflation rate. In fact, you might be losing your valuable money.
Take for example, a business owner has $100,000 in a time deposit bank account with an interest rate of 1%, and so the money will grow to $101,000 the following year. However, if the inflation rate is at 4.4 %3, then the value of his/her money will only be $ 96600—the $1,000 you gained cannot make up for the PhP 4 ,400 value lost because of inflation.
- It makes it harder for your income to keep up with rising prices, reducing your standard of living. This especially affects those on fixed incomes like retirees.
Let’s say, a grocery bag with bread, fish, rice, meat, vegetables, and fruits that costs $600 in 2023 would cost about $631.2 in 2024. In the same way, if you spent $500 for water, electricity, and gas in 2023, the very same utilities would cost $526 in 2024.
- It devalues the real worth of your investments, as the future cash flows they generate are worth less in today’s dollars. Bonds and growth stocks tend to underperform during high inflation.
For investors who count long-term, conservative investments as a significant part of their net assets, inflation can be a dirty word. This is because these traditionally safe investments, like bonds, often require investors to lock into a guaranteed rate for a long time. Inflation creates a situation where these long-term investments that pay a low interest rate have decreased buying power because inflation pushes up the price of goods and services.
- It increases the real cost of borrowing, as lenders demand higher interest rates to compensate for the declining value of repayments.
How does this happens?
When the Federal Reserve raises interest rates, it makes it more expensive for banks to borrow money from one another. These increased rates are then passed on to individual and business borrowers. The bottom line is that higher inflation means higher interest rates on the money you borrow — and less money in your pocket.
How to protect your money from inflation
To mitigate the effects of inflation, we recommend strategies like budgeting, increasing income streams, reducing expenses, and investing in assets that tend to hold their value better, like real estate. These can be achieved through: –
- Avoid Excess Cash: Instead of holding excessive cash that loses value over time due to inflation, invest in assets that can preserve or grow your wealth, like stocks with pricing power1.
- Diversify Investments: Consider adding inflation-resistant diversifiers to your portfolio, such as commodities, real estate, and international stocks, which historically perform well during inflationary periods2.
- Invest in Treasury Bonds: Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds are low-risk options that can protect your investments against inflation by adjusting their value based on inflation rates3.
- Explore Alternative Investments: Look into alternative investments like commodities, real estate, and gold, which can provide a hedge against inflation and help diversify your portfolio3.
- Stay Invested in the Stock Market: Investing in stocks, especially those with pricing power, can help your money grow faster than inflation, as these companies can pass rising costs on to consumers and maintain profit margins