Stay ahead of inflation by putting your money in high-yield savings accounts and investments.
One million dollars might sound like a lot of money — and it is — but in 10 years it will probably sound like less money because it will have less buying power than it does today.
The reason is inflation, and it can impact how you plan for your financial future. Here’s a look at what inflation is and how it can affect your savings, as well as how to keep it from derailing your short- and long-term financial goals.
What is inflation?
Broadly speaking, inflation is the rate of increase in prices for goods and services. It can happen because of an increase in the cost of producing those goods and services. Another reason could be that demand is higher than the supply, leading to price increases. Whatever the cause, as prices rise, you’ll need more money to buy the same things you used to buy for less.
How inflation affects savings?
Along with a change in prices, inflation can affect your savings and how much you need to put away for unexpected financial emergencies. A good emergency savings fund should have enough money to cover three to six months of living expenses. But over time, if your expenses increase because of inflation, the amount you need to put away should increase, too, or else you could come up short in a pinch.
How much are prices rising?
Near the end of 2021, inflation topped 6% according to the Consumer Price Index, published by the Bureau of Labor Statistics. This index is one of the most common measures of inflation. So, if you kept cash in a safe — instead of depositing it in an interest-earning savings account — you would expect it to have 6% less spending power this time next year due to inflation if the rate stays the same. For historical context, the long-term average rate of inflation has generally been between 2% and 4% annually.
Where to put your money to help combat inflation?
You can’t stop inflation, but you can make your money work to try and keep up with it. These strategies can help.
Put short-term savings in a high-yield account
The best savings accounts currently earn around 0.40% annual percentage yield and while that may not currently beat inflation, it is much more than the average savings rate of 0.06%, and will get you more money than the zero extra dollars you’d earn if you stash your cash in a safe. It’s important to note that the role of your short-term savings is to provide easy access to your money when you need it, not necessarily keep up with inflation.
You’ll want to get in the habit of adding up your monthly expenses on a regular basis and comparing the total to how much you have saved (remember that three to six months’ worth is ideal). If your savings balance needs a boost, consider setting up regular automatic deposits from checking to savings — you could transfer a certain amount each payday, for example — to build your rainy day fund.
Use investments for long-term savings
If your short-term savings is fully funded and you are looking for ways to make your extra money work harder against inflation, consider that the stock market has had average returns in the past century of about 10% annually. There is no guarantee that future earnings will continue to match that rate, and when you factor in inflation, it could leave the real return closer to 4%. But even so, investments can be your best bet for earning long-term returns that beat inflation.
If you are saving for retirement, you can put your investments in a 401(k) or IRA and take advantage of valuable tax benefits, too.
Should I worry about the cost of inflation?
Inflation isn’t always bad news. As prices rise due to increased demand, businesses may need to hire more workers to fill that demand, which can lead to higher wages. In addition, government benefits, including Social Security, may have cost-of-living increases. If recipients are able to keep at least some costs low, it could mean more spending power.
Lower inflation rates, on the other hand, can lead to lower interest rates, which makes it harder for savers to earn high yields in their accounts. Overall, the Federal Reserve holds its long-term target rate for inflation at 2%.
You can’t control inflation, but you don’t have to let it erode your savings, either. Be smart about where you put your money, keep an eye on your expenses and you can reach your savings goals without missing a beat.
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