How Does Inflation Affect Savings?

Inflation is a reflection of the purchasing power of a dollar. Any increase in the Consumer Price Index (CPI) is considered inflation and as a rule, the Federal Reserve assumes an annual inflation rate of 2%.

At Addition Financial, we understand the impact that high inflation is having on our members in 2022. We’ve been fielding a lot of questions about inflation and one question we’ve been hearing a lot is this:

“How does inflation affect savings?”

Anybody who wants to save money, whether they’re saving for a family vacation, holiday shopping or retirement, is bound to be curious about how high inflation will impact their savings. Here’s what you should know.

How Does Inflation Impact the Value of Money?

To understand how inflation can affect your savings, it’s necessary to begin with an understanding of how the inflation rate affects the value of money.

High inflation has a serious impact on the cost of living, that is, how much it costs to pay for basic necessities such as housing, food, healthcare and taxes. When inflation is high, the cost of everything from necessities to luxury goods increases at a higher-than-normal rate.

It may be helpful to look at an example of rising prices. According to the Bureau of Labor Statistics, a pound of chicken cost $1.44 in July of 2021. As of June of 2022, the price has risen to $1.83, an increase of 27%. Said another way, your dollar buys less chicken in the summer of 2022 than it did in the summer of 2021.

As inflation increases, the purchasing power of every dollar you earn or save decreases. Like most Americans in 2022, you have likely noticed that the same groceries you bought in 2021 cost significantly more now. You may have already adjusted your shopping list in an attempt to keep your grocery bill at a reasonable level.

How Does Inflation Affect Savings Accounts?

If you have money in a savings account, whether it’s a traditional account or a high-yield account, then you may be wondering how higher inflation will affect your savings.

The answer lies in comparing the inflation rate to the return on your savings. A typical savings account at a bank earns a low interest rate. The national average as of July of 2022 is just 0.08% APY, putting it well below even a typical cost of living increase. The rates are usually higher for credit union accounts, which may pay dividends of 1% or more.

The rate of inflation as of July 2022 is 9.1%. You don’t need a calculator to see that inflation is far outstripping whatever interest or dividends you may be earning on your savings account, even if you have your money in a high-yield account. 

If your money is in a savings account, then you are losing spending power each month when inflation is high. Not only are the interest rates lower than inflation, but savings accounts are not designed to keep pace with inflation as some investments are.

Do You Lose Money in Savings Due to Inflation?

Nobody likes the idea of losing money, particularly when it’s lost due to something beyond their control. Here are some things you should know about what happens to your savings when inflation is high.

The first thing to understand is that you won’t lose money – at least you won’t lose dollars. If you have $10,000 in savings before inflation rises, you will still have $10,000 (plus any interest or dividends you earn) when inflation falls back into the normal range. Inflation doesn’t have the power to remove money from your savings account.

What you will lose during inflation is the value of your dollars. $10,000 buys more when inflation is within the normal range, which typically runs from 1.5% to 4%, than it does when inflation is high. As the price of consumer goods and services increases with inflation, the spending power of your money decreases.

What might that mean for you? A lot depends on why you’re saving money. For example, say you have an emergency fund that you expect to pay for six months’ worth of necessities, including your rent or mortgage, groceries, utilities, insurance and transportation. If you calculated how much you needed based on your expenses when inflation was normal, the chances are good that your savings will no longer be sufficient to last six months.

Let’s say you calculated that you would need $2,000 per month to pay for everything and you have $12,000 in savings. You can total your current expenses to determine how much more you would need to save to be safe. Your mortgage payment will stay the same but you’re probably paying more for groceries, utilities and transportation. 

You still have the same balance in your emergency savings account that you had before but it’s no longer enough to cover the expenses you want it to cover. In other words, your dollars have lost value as a result of inflation.

How Can You Protect Your Savings from Inflation?

While rising inflation can be upsetting and stressful, there are some things you can do to protect your savings from inflation. Here are some pointers.

Invest Your Money in Asset Classes That Outperform Inflation

During times of high inflation, a savings account won’t protect your money from losing value. The alternative is to put your money into investments that can reasonably be expected to outperform inflation. Here are some examples:

• Gold
• Real Estate Investment Trusts (REITs)
• Commodities (examples include precious metals, grain, foreign currencies, oil and natural gas)
• The S & P 500
• Treasury Inflation-Protected Securities (TIPS)
• A 60/40 stock/bond portfolio

The benefit of investing in these higher-return asset classes is that there’s a strong chance that your money will grow faster than the rate of inflation, meaning that you won’t lose purchasing power even when inflation is high.

Examine Your Spending

Another way to protect your savings is to focus on what you’re spending. While you may not have dipped into your savings yet, there’s a greater risk that you’ll need to do if inflation remains high.

Here are some pointers to get your spending under control:

• Rein in discretionary spending. Most of us spend money where we don’t need to. This might be a good time to start cooking at home or rent movies instead of going to the theater. You may also want to look into free entertainment in your area.
• Shop strategically. It’s easy for spending to get out of control when you’re not thinking about it. An inflationary period is a good time to identify generic products to buy instead of brand name options, buy in bulk at membership stores like Costco and call utility companies to renegotiate your bills. You might be surprised at how much you can save by calling and asking.
• Review your subscriptions and cancel any you aren’t using. For example, you might want to track the time you spend on streaming services and eliminate those that you’re not watching. If you can’t remember the last time you watched anything on Hulu, you can save money by canceling it. You may also be able to identify subscriptions by using an app like Truebill. (Bonus: Truebill will even do the work to cancel subscriptions for you!)

After you’ve reviewed your spending, consider revisiting your monthly budget (or creating one if you don’t have one) to keep spending in control. 

Increase Your Income

When the purchasing power of your money decreases, one way to combat the situation is to find ways to increase your income. We recognize that might not always be easy to do, but here are a few suggestions to consider:

• Sell things you don’t use. A lot of us have belongings that we don’t use regularly. Maybe you’ve lost interest in a hobby and have supplies or equipment that you’re no longer using, or you have an extra TV that you don’t need. Whatever items you have that you’re not using have value and could potentially be sold to help you bring in a little extra money.
• Find a side gig. Not everybody wants a side gig but having one can help eliminate some of the stress of inflation rates by increasing your income. You might have a passion or hobby that could be monetized, or you might choose to pick up some freelance work or work a weekend shift at your local bookstore.
• Ask for a raise. If it’s been a while since you asked for (or received) a raise, then this is a good time to do it. Your value as an employee puts you in a position of power in negotiations. It’s common for people who have worked for the same employer for a long time to be underpaid, so do some research and request a salary increase to put you in line with what others in your field are making. The worst that will happen is that your employer will say no and if they do, you can start sending out resumes.

Even a small increase in your income can make a difference in how you weather inflation, so get creative!

Inflation may decrease the purchasing power of the money you’ve saved, but that doesn’t mean you need to take it lying down. Using the tips and suggestions we’ve included here can help you protect your savings and ensure you’ll have the money you need to meet your financial goals.

Do you need help choosing stock investments that keep pace with or outperform rising inflation? Addition Financial has the solution you need. Click here to learn about our MEMBERS Financial Services program and schedule an appointment with a Financial Professional today.