How Inflation Affects Your Savings
Inflation happens when prices increase for things like labor, production and debt payments. As these prices rise, the price of all products and services go up. If your savings are not in inflation-protected investments, the money will be worth considerably less when you finally take it out of savings and try to spend it. You should consider the following when looking for ways to protect your savings from inflation:
Other ideas for protecting your savings include index funds, which are easy to invest in, have low costs and provide easy diversification. Individual stocks are also a great choice, since company stocks will often rise with inflation, as they are able to pass along price increases to their customers.
- Causes of Inflation. Inflation has many causes including when the government prints excess money to deal with a crisis, when production costs rise, when labor costs rise and importantly when international lending and national debts increase. The federal government can also cause inflation through increased federal taxes on consumer products such as cigarettes or fuel.
- How Inflation is Measured. The most recognized way of measuring inflation is through the Consumer Price Index (CPI). The CPI looks at the average change in prices over time paid by consumers for a "market basket" of consumer goods and services. The CPI is determined by the Bureau of Labor who surveys about 7,000 families from around the country on their spending habits and regular expenditures.
- One way to measure the impact of inflation is through the Rule of 72. Divide 72 by the inflation rate. This will give the number of years it will take for costs to double.
- Protecting Savings from Inflation. Treasury Inflation-Indexed Securities (TIPS) are one strategy for protecting savings from inflation. The U.S. government uses the CPI index to adjust the value of your principal every six months to account for inflation. As an example, if the CPI went up 3%, the principal on the investment would go up by 3%. You can invest directly in TIPS through the government or there are also funds that invest in TIPS for you.
Remember to factor in inflation to your savings and investing plan. If you ignore the affects of inflation your investment return will be significantly less and your savings dollar will not go as far when you finally pull the money out.