Inflation is a natural part of any economy and it can have a dramatic effect on your savings and investments. It occurs due to more money chasing fewer goods and services; thankfully there are ways you can combat inflation.
Investments that outpace inflation rates may help protect purchasing power over time. When designing your financial plan, you should include inflation rates.
Inflation is a natural part of the economy
If your money doesn’t stretch as far, don’t panic; that is simply due to inflation – a natural and unpredictable fluctuation between supply and demand that occurs periodically.
An increase in inflation can help boost the economy if it’s managed responsibly and doesn’t lead to recession. To combat inflation, the Federal Reserve (commonly known as “The Fed”) can increase interest rates which make borrowing money more costly and encourage people to reduce spending by making it more expensive for people to borrow money and encourage less borrowing of it from banks.
inflation can make a country uncompetitive, making its products unattractive to outside markets. When inflation occurs in one country, other nations can sell the same items at reduced costs (X). High inflation discourages investment as its outcome can be unpredictable; this is particularly damaging to businesses that rely on fixed-price contracts like homebuilders and manufacturers; those owning tangible assets like real estate or stocks benefit as they can buy more with their available funds.
It affects your buying power
If your wallet feels lighter recently, inflation could be to blame. As prices increase and costs escalate, inflation has an ever-increasing effect. Inflation refers to an ongoing increase in what things cost; something we must face every day.
Though moderate inflation rates can benefit both businesses and consumers alike, too much inflation can put strain on people’s wallets. The Federal Reserve targets an inflation rate of no more than 2% per year to provide price stability without increasing interest rates or restricting spending.
Inflation-protected assets can help cushion the impact of rising costs on your savings and investments over time. You have many options such as 401(k), HSAs and 529 plans available that can help preserve the purchasing power of your hard-earned dollars; another alternative could be investing in real estate or collectibles that appreciate in value or generate interest.
It affects interest rates
Inflation has an enormous effect on your finances and investments. When prices increase quickly while your wages do not, savings become less purchasing power-intensive over time. But the good news is there are steps you can take to combat inflation.
One investment option that could outstrip inflation is investing in stocks; however, you should be mindful that investing in individual stocks carries its own set of risks. Mutual funds and exchange-traded funds (ETFs), however, can provide a diversified portfolio that reduces market volatility risk.
An alternative strategy for saving is opening an online savings account with high interest rates and no account fees, enabling you to compare rates from various banks to find what best meets your financial goals.
It affects investments
Inflation is a silent attacker that threatens your real savings and investment returns, gradually diminishing their purchasing power over time. Your investments must outstrip inflation if they want to stay relevant against rising prices.
Savings accounts, money market funds and CDs are particularly vulnerable to inflation due to their relatively low interest rates – often not enough to offset its effects. Furthermore, inflation erodes purchasing power as your money loses value over time.
Investors can avoid this problem by investing in inflation-adjusted bonds and other fixed income investments that rise with inflation, or looking at their investments’ “real rate of return”, which takes inflation into account and shows their true purchasing power. According to Nobel laureate Robert Mundell and economist James Tobin, moderate inflation promotes savings by reducing market-clearing real interest rates.