How Inflation Affects Your Savings and Daily Expenses

How Inflation Affects Your Savings and Daily Expenses. 

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Of all the economic jargon we hear day after day in the news, inflation is one that is not fully understood until you're at the grocery store and you see your dollar savings decline or you notice when you go to your bank account, you haven't saved as much as you thought. In simple terms, inflation is a continuous rise in prices in the economy over time. As inflation increases, each dollar or euro will purchase fewer items and services than before. A moderate level of inflation is a healthy economy, but it can have a big impact on your daily life and long-term financial goals.

Although he sold his boat, he didn't sell his home.He sold his boat but not his home.

Inflation's direct impact on you is through purchasing power. If the rate of inflation is three percent per year, a dollar today will be a dollar and three cents next year. This seems insignificant, but it all adds up over time. The same product might be almost twice as expensive 20 years from now.

This erosion is especially harmful for those who are on a fixed income, retirees on their saving accounts, and those who have a significant amount of funds in low-yield savings accounts. The numbers on your dollar bills might be the same, but the bills don't go as far as they once did. That $100 bill you have in your pocket today is not the same $100 bill you'll have 5 years from now. And that is the essence of the inflation issue for consumers in general.

The impact of inflation on your daily expenses.The effect of inflation on your daily cost.

First up, the most obvious place: your day-to-day spending habits. If inflation starts to pick up, it will be noticed first in your fixed costs, such as groceries, utilities, and transportation. Food prices are often more volatile to inflation as they are affected by the fuel prices, weather, and the global supply chain. You may find that you're spending $10 or $20 more on groceries each week, but you haven't changed your shopping habits or purchased anything additional.

Inflationary times often bring gasoline prices to the fore and as crude oil costs increase. Not only does this impact your commute, but it also has a ripple effect throughout the economy because transportation costs are part of the cost of nearly every product we purchase. This drives up fuel prices and thus shipping costs leading to higher store shelf prices.

Inflation is also felt in the housing market. The rent usually rises with inflation, since landlords want to earn their profits in relation to the inflation. Property taxes and maintenance costs also tend to increase if you own your home. The cost of electricity, water and gas also rises when the commodities they are using are more expensive.

Expenses for services, such as health care, education and insurance premiums, tend to rise more rapidly than the overall inflation. Even if your plan doesn't change, you could see a big increase in your annual health insurance premium. During inflation, daycare fees, gym fees, and even streaming services are likely to go up.

The Hidden Tax on Your Savings

The worst thing about inflation may be how it affects your savings. In a standard savings account, if you make 1 percent and inflation is at 3 percent, you're losing 2 percent of your buying power each year. With only a small increase in your account, you could be falling behind in real numbers.

This is especially problematic for savings for emergencies. It's nice to have a little cash on hand, but too much cash is not always better when inflation is high, and your “safety net” is being slowly eroded. All of the twenty thousand dollars you saved for emergencies five years ago may only have a value of approximately seventeen thousand dollars today.

Other investments like certificates of deposit and bonds are also susceptible to inflation. If you invest in a five-year fixed-rate bond with a 2 per cent nominal interest rate and experience a 3 per cent average rate of inflation over the five years, your final investment balance will be less than the value you put in. This is called the "interest rate risk" plus the "inflation risk" and that can be a double blow to conservative savers.

The impact on debt and borrowing.The impact on debt and borrowing.

There is more than one way inflation works—it's not all bad. Inflation may help those who have a fixed-rate debt such as a mortgage or student loans. The principal of the loan that you pay back will be less than the principal amount of the loan. Basically, inflation lowers the worth of your debt in real terms. This advantage is only provided when earnings are keeping up with inflation. When the cost of goods goes up but your income doesn't, your debt payments increase as a percentage of your income.

When the inflation rate increases, the credit card debt becomes costlier because interest rates are increased when the central bank tries to slowdown the economy. The interest costs on variable rate loans and lines of credit will go up, making it harder for consumers to low up.

So how can you avoid inflation?How can you protect yourself from inflation?

When it comes to safeguarding your money from inflation, you need many layers of protection. The first thought you should have is to keep your emergency fund in a high-yield savings account or money market account with a rate that's at least as close to the inflation rate as possible. These are not as effective as a savings account during periods of high inflation, but they are better than a savings account.

Another strategy is to invest in assets that are likely to appreciate faster than inflation. The history of stocks is that they have historically outpaced inflation over the long-run period, but have added volatility. Real estate can be a good hedge against inflation, since rents and property values usually move in tandem with inflation. Treasury Inflation-Protected Securities are government bonds that are designed to avoid losing purchasing power due to inflation, and use the Consumer Price Index (CPI) to adjust the principal value of the bond.

Spread your investing powers over a variety of asset classes, sectors and geographic areas to minimize the effects of inflation on your portfolio. In times of inflation, gold and oil are often good investments, but they can be unstable.

Be aware of what you are buying is one way to help you spend less. When purchasing non-perishable items, buy them in bulk, find sales and coupons, and compare prices before making large purchases.