At a time when prices are steadily climbing and budgets are stretched thin, it’s understandable why many individuals worry about inflation. Inflation erodes the purchasing power of your money quickly unless your income increases significantly.
By investing your money wisely, it can keep pace with inflation and even grow in value. Here’s how.
Increase in Prices
Inflation impacts prices and costs of living, eroding savings and investments’ purchasing power. It poses serious problems for consumers, businesses and investors alike – particularly consumers as they find that their money doesn’t buy as many goods and services.
Workers will also feel the effects of inflation; with wages not growing at an equal pace and losing value due to rising prices, workers could find themselves having to take on second jobs or tap into emergency funds in order to survive financially.
Inflation can damage investment returns, particularly those with fixed interest rates like bonds, bank certificates of deposit and some pension funds. Your accumulated wealth will diminish over time if inflation outpaces interest payments; diversifying with stocks can help mitigate this effect.
Loss of purchasing power
As a consumer, business owner, saver or investor, inflation can have a devastating effect on your purchasing power. Over time prices rise steadily, meaning a fixed amount can buy less goods and services with each passing year.
Cash savings are particularly vulnerable to inflation; over time their purchasing power declines as time passes. If, for example, you stashed away $10,000 and inflation increased at 2.5% annually, that money would become worth less after 20 years than it is now.
Saving and investing are crucial strategies for mitigating the loss of purchasing power caused by inflation, such as shares or market-based investments that provide higher long-term returns than cash savings or low interest bank accounts. Saving is especially crucial during periods of high inflation to maintain lifestyle standards while working toward long-term goals.
Though inflation can be upsetting, a little is generally beneficial. Modest levels of inflation indicate a strong economy and encourage people to spend rather than keep cash under their mattress. Expectations also play a part; consumers and businesses often factor anticipated price increases into wage negotiations or contractual pricing adjustments.
Inflation also benefits borrowers. As prices increase and interest rates follow suit, they allow borrowers to service debt at lower repayment costs than would be the case with deflation.
But even small inflationary increases can wreak havoc on stocks and other investments priced in dollars, creating significant losses for investors who rely on buying shares at reduced prices (known as the “buy the dip” philosophy). For instance, during 2008’s financial crisis mortgage and finance companies such as Bear Stearns and New Century Mortgage saw their shares plummet compared with precrisis highs.
As your high school economics class may have taught, inflation can eat away at your earnings and savings over time, diminishing their purchasing power and making future planning for them difficult.
Inflation’s greatest impact can be felt through cash savings; when each dollar no longer buys as much than it did years earlier. But with an investment that outpaces inflation rates, your money should retain its purchasing power and continue to expand.
For the best protection from inflation, invest your savings in assets that grow their value at a faster pace than inflation, such as equity mutual funds and systematic investment plans. Alter your spending habits so that money goes further; switch brands or take public transport.