What you need to know about inflation and your money.
Inflation is the decline of purchasing power of a given currency over time. As prices for goods and services increase, the money in your wallet is unable to buy as much. But the effects of inflation on your finances extend beyond pricier items.
What causes inflation?
Inflation can be caused by many factors, from higher costs for materials and labor to supply chain issues. If a good or service is in high demand but there is not enough for everyone, the cost of those items tends to rise. Similarly, if the materials needed for an item are not widely available or the labor needed to create the item cannot be found, inflation rates can increase dramatically. Inflation is often calculated using the Consumer Price Index (CPI), which is compiled by the U.S. Bureau of Labor Statistics and includes the prices paid for various goods and services across eight categories. Additional metrics for determining inflation rates can be found via the Personal Consumption Expenditures price index (PCE), which is calculated by the U.S. Bureau of Economic Analysis and also includes categories of different services and goods. Other statistics can also come from the Wholesale Price Index (WPI) and the Producer Price Index (PPI).
How does inflation affects savings?
When you have money in a savings account, you typically accrue interest over time. But if the rate of inflation is higher than your savings account interest rate, you are actually falling behind when it comes to saving. The value of your money is then lower than it was when you first put it into the account. For example, if you have $100 in a savings account that pays a 1% interest rate, after a year you will have $101 in your account. But if the rate of inflation is 2%, you would need $102 to have the same buying power you started with. Additionally, if you do not have your savings in an account accruing interest and instead keep it in a safe at your home, you are losing out even more.
Ways to safeguard your finances
There is no one way to guarantee that your personal finances will be protected from the results of inflation. But there are ways you can increase your income and keep your money from becoming stagnant. One option for fighting inflation is to invest in stocks or a Treasury Inflation-Protected Securities (TIPS) exchange-traded fund (ETF). TIPS are a type of bond that helps investors preserve purchasing power because they are indexed directly to CPI. When it comes to stocks, the interest rates for these investments tend to increase with inflation and have larger payouts. However, investing comes with its own risks and rewards that you should seriously consider before putting your life savings behind something. If you are not interested in investing directly into stocks or ETFs, you can acquire real assets to improve your finances. Real estate and gold are two assets that often retain value or provide pricing power to combat inflation.
Inflation can have a drastic impact on how we live. Understanding how it occurs can help you safeguard your finances for a more fruitful future.
Learn more about how inflation affects your finances by visiting the Five Star Bank Financial Education Hub.
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- NOT A DEPOSIT
- NOT FDIC-INSURED; NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
- NOT GUARANTEED BY THE BANK
- MAY LOSE VALUE
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