Prices of goods and services continue to rise, meaning your savings in a savings account, mutual funds or real estate investments will lose purchasing power over time. Therefore, investing your savings is recommended over keeping it under your mattress.
However, inflation can be beneficial to our economy and most governments strive for manageable levels. Therefore, it is crucial that we educate ourselves about its effect on savings and investments.
What is Inflation?
Inflation refers to an overall rise in prices that causes each monetary unit to buy less goods and services in aggregate. This decrease in purchasing power presents many households with challenges as costs continue to escalate, particularly those living on fixed incomes who find it challenging to keep pace with rising expenses.
As inflation raises the prices of physical assets, those who hoard may benefit; however, this may also create shortages if people withdraw money from savings or investments in order to purchase these items. It is therefore crucially important that one carefully considers its effect when financial planning.
Savings accounts and money market funds generally offer very low interest rates that fall below inflation, meaning their value slowly diminishes due to inflation. To protect yourself against this scenario, it would be beneficial to save or invest using strategies which beat inflation instead.
Cost-Pull Inflation
No matter its cause, inflation erodes everyone’s purchasing power. Cost-push inflation can be particularly devastating.
inflation can occur when demand for goods and services outpaces suppliers’ ability to respond immediately, such as when commodity prices increase sharply or when central banks increase money supply without matching it with increased production.
Some economists argue that inflation can be beneficial. It benefits those with fixed economic items like mortgages and vehicle leases. Also, people in permanent jobs or with businesses benefit as their profit margins increase due to inflation. On the other hand, those receiving Social Security or investing in bonds may experience decreased payments with each inflation rate change, although their benefits will adjust accordingly.
Cost-Push Inflation
Cost-push inflation arises when production costs increase due to raw material or wage shortages, leading to price hikes for finished goods and providing workers with increased spending power that boosts the economy overall. Furthermore, higher wages allow companies to realize greater profit margins that ultimately benefit shareholders.
Cost-push inflation can also occur when natural disasters or wars disrupt supply chains, driving up the price of essential materials like oil, steel, energy and other commodities – leading to higher consumer spending as they pass onto consumers at increased rates.
Though most people view inflation as something negative, even minor amounts can actually benefit the economy. It’s essential that investors understand how this type of inflation works so they can make smart investments and avoid falling prey to its traps.
Built-In Inflation
Many are concerned about inflation because they believe it erodes their savings’ purchasing power, even moderate inflation can diminish this purchasing power of currency.
Consumer Price Indexes (CPIs) provide an effective method of tracking inflation; CPIs measure price changes of goods and services with fixed baskets of items – for instance if used car prices increase 10% year over year this represents a 5% rise in CPI.
One way you can safeguard your buying power against inflation is to invest in assets that earn more than its rate, such as TIPS bonds which offer fixed returns but whose principal adjusts annually according to inflation. You could also consider bank certificates of deposit which pay an annual set amount in interest; some financial professionals recommend them in order to mitigate its effect on income.
