Whenever people discuss finances, the conversation inevitably turns to inflation. Inflation refers to the increase in priced goods and services over an extended period of time. In other words, as the price of goods increases, the value of currency decreases.
It’s easier to understand how inflation impacts our daily lives as grocery budgets expand and housing costs increase. Yet it can be harder to understand the longer-term impact of inflation or what it does to your savings or the overall value of your money.
Increase in Expenses
As already mentioned, there is an immediate impact on finances when it comes to inflation. The cost of everyday goods and services increases, meaning that one has to spend more to obtain the same amount of goods. This, in turn, reduces the overall amount of money one has and can potentially put into their savings.
To put it another way, as inflation increases, paychecks steadily cover less than they did previously.
Inflation in Savings
Inflation does more than impact the cost of everyday items. It can also have an impact on a person’s savings accounts. Assuming that one has a savings account that provides interest if the inflation rate exceeds the interest rate, the savings account is ultimately reducing in value.
This can be difficult to picture, as interest rates will generally allow untouched savings accounts to accrue over time. However, it is critical to recall that the value of the money, which makes up the savings account, is what is being affected here. So while the number inside the account may be going up, the overall value is going down.
Conversely, if the inflation rate is lower than one’s interest rate, the account will accrue value in every sense of the word.
Investments
Naturally, inflation also impacts longer-term financial planning, such as investments. For example, inflation is one of the few things that can impact fixed-income investments, as it alters the purchasing power of those accounts.
Stocks tend to be less heavily impacted by inflation. It is essential to remember that stocks generally have their own fluctuation metrics, making this calculation more complex. As such, the value of stocks is highly dependent on several factors.
Finally, tangible assets, such as real estate and commodities generally see a significant increase alongside inflation. This makes sense, given that inflation impacts the price of goods, putting more value behind them. Those that trade in goods will thus be rewarded as inflation rises.