Understanding the Impact of Inflation on Your Savings

Rising inflation is something that has been an ongoing concern for people of all ages and income levels. While the inflation rate slowed a bit in the second half of 2023 and going into 2024, it has still outstripped economic growth and impacted consumer spending. Most people don’t have enough household income to keep up with increases in the Consumer Price Index. 

There’s been a lot of discussion at Addition Financial about inflation and how it affects our members. One thing that we believe everyone should understand is the impact of inflation on savings. What could future inflation mean for your financial health? Here’s what you need to know.

How Does Inflation Impact Your Savings?

We believe that everybody should make saving money a priority, but it can be difficult in times of higher inflation. Households in every income group feel the pinch. We’re all paying more for basic needs such as groceries. Here are some of the key ways that inflation can impact your savings.

It Decreases the Value of Money

When inflation is low, it happens slowly enough that you may not notice small price increases or feel too much of an impact on your budget. But when inflation is high, you’ve probably noticed that your money doesn’t go as far as it did before. 

The impact on savings is that the money you have saved may not be enough for your needs. For example, you might have an emergency fund that is supposed to have enough money to pay your expenses for six months. With inflation, that amount might only pay for five months of expenses, or four.

It May Increase Your Interest Rate

Interest rates for savings accounts are only loosely linked to the Federal Reserve System and the adjustments it makes to interest rates. In most countries, including the US, monetary policy calls for increases to interest rates to counterbalance inflation. That means that if you have a high-yield savings account, an interest rate increase from the Fed may result in a slight increase in your interest rate as financial institutions try to stay competitive.

It’s unlikely that a small bump in your interest rate will be enough for your savings to keep pace with inflation, but you should keep an eye on your rate. An increase could partially offset rising prices and give you a bit more spending power.

It Can Make Financial Goals More Difficult to Achieve

Even if you’ve been diligent about saving money, inflation may make it more difficult to reach your most important financial goals. If you were trying to save money for a down payment on a home, inflation could push that goal back.

Here’s an example. Let’s say that you had a budget that allowed you to put 15% of your take-home pay into savings every month. The rising price of consumer goods might not allow you to save as much each month. You might need to move more money into spending categories to make ends meet, especially if your income is the same.

Can You Predict How Inflation Will Affect Your Savings?

Many of our Addition Financial members have asked us if there’s a way to predict how inflation will affect their savings. While there’s no way to be sure what will happen in the future, here are some things to keep in mind.

Ongoing High Inflation Will Impact Your Purchasing Power

The easiest prediction to make about inflation is that if it continues at a high rate, it will negatively impact your purchasing power. It may be helpful to look at an example.

The Bureau of Labor Statistics reported that in 2019, the average household spent $386.92 per month on groceries. That works out to $4,643 per year. As of the middle of 2023, that amount has increased to $415.53 for an increase of 7.4%. Areas with a high cost of living are likely to have a higher price than the average.

If inflation continues to be high, the amount you can buy with your savings will decrease. There are some investments that can outperform inflation, and we’ll talk about those later in this post.

Inflation May Impact Your Ability to Save

One of the biggest causes of concern with inflation is how it can impact long-term financial goals. As we noted above, high prices may make it difficult to stick to your savings goals, particularly if you haven’t received a raise or otherwise increased your income.

A lot of people have had to re-evaluate when they’ll be able to achieve their goals. Or, in some cases, they’ve had to revise their goals. An example would be someone who wanted to save enough to make a 20% down payment on a house. Saving that much would mean a lower interest rate and instant equity in their home. According to Bankrate, the median downpayment for a home in the US, as of quarter two of 2023 is $31,500. This is higher on average than past tears.

In a time of rising inflation, their goal could be affected in multiple ways. First, it could be difficult to save as much money as they want and it might take them longer to reach that goal. Second, if the Federal Reserve increases interest rates, they may not be able to get as low a rate as they would in a period of lower inflation.

You May Need to Dip Into Your Savings

Finally, you’ll need to consider that ongoing high inflation might mean you need to dip into your savings to pay for ordinary expenses. With prices for everything from groceries to rent on the rise, you may not be earning enough to keep your savings intact.

There are people who have already depleted their savings accounts as a result of inflation. Some have even had to borrow against retirement savings. If you can avoid doing so, that’s what we recommend. 

How Do You Protect Your Savings from Inflation?

Inflation expectation is that while the rate of inflation has slowed a bit, rates are likely to continue to be higher than normal. The good news is that there are some things you can do to protect your savings from inflation.

Review and Decrease Your Spending

The biggest impact of high inflation is in consumer spending. You can preserve and protect your savings by finding ways to lower your spending during times of high inflation. Here are some examples:

  • Buy groceries in bulk or choose generic options over brand names.
  • Go to stores that offer everyday low prices instead of sales. Aldi is an example.
  • Review your subscriptions and cancel any that you aren’t using regularly. We recommend checking which services you can get for free. For example, some phone providers offer free streaming services with some of their plans. 
  • Decrease your entertainment budget. Opt for cooking a special meal at home or watching something on TV instead of going to the movie theater.

You may be able to save quite a bit with these strategies and they can allow you to put money into savings even when inflation is high.

Reallocate Your Investments

Some investments are likely to be outstripped by inflation while others may be indexed to inflation or even have a tendency to outperform inflation. Rebalancing your investment portfolio to incorporate these items can preserve your purchasing power. Here are some examples:

  • Commodities: Rising consumer prices can be a good thing if you invest in the right way. Putting some money into commodities such as grain or precious metals can help your portfolio’s performance during high inflation.
  • Treasury Inflation-Protected Securities, or TIPS: They’re indexed to the inflation rate but interest rates may also impact them, so be aware that they’re not suitable as a hedge against deflation.
  • Real Estate Investment Trusts, or REITs: We wouldn’t recommend choosing real estate as an investment, since the money you put into it won’t be liquid and accessible. However, REITs represent a way to keep some of your portfolio in real estate while still being able to access it. 

In times of high inflation, proper asset allocation is essential. As a rule, stocks perform far better than bonds during high inflation, so you may want to review your allocation and adjust it accordingly.

Create a Side Hustle

Depending on your financial circumstances, you may need to consider a side hustle or second job to keep up with inflation and add to your savings. Earning a little extra money each month may mean the difference between adding to your savings or withdrawing them.

If you decide to create a side hustle, make sure that you take any expenses associated with it into consideration. Transportation, gas or child care expenses might cost more than you can earn, in which case you’ll need to find another way to preserve your savings.

Switch to a High-Yield Savings Account

Finally, if you’ve got a traditional savings account, you may want to consider moving your savings to a premium or high-yield savings account instead.

While high-yield accounts don’t pay enough interest to keep up with inflation when it’s at 8%, you can get a significant bump in your dividend or interest rate, and that can help you to hedge against inflation and protect your savings.

Protect Your Savings with Addition Financial

There’s no denying that high inflation will have an impact on your savings. The information and tips we’ve listed here can help you minimize that impact and preserve your savings. You may even be able to add to them if you choose the right investments.

Do you need a high-yield savings account to protect your savings? Addition Financial can help! Click here to read about our personal savings accounts and become a member today.

The content provided here is not legal, tax, accounting, financial or investment advice. Please consult with legal, tax, accounting, financial or investment professionals based on your specific needs or questions you may have. We do not make any guarantees as to accuracy or completeness of this information, do not support any third-party companies, products, or services described here, and take no liability or legal obligations for your use of this information.