Can My Savings Lose Value? A Lesson on Inflation
When you work hard to develop and adhere to a budget so you can put aside money, you don’t want to discover that it’s lost value. Is that a risk for your savings?
The simple answer is yes: your savings can lose value over time due to inflation. As it stands now, savings accounts, even the high-yielding accounts, have such low percentage rates that inflation is more likely to impact your savings when compared to other appreciable assets and investments. So, what is inflation exactly?
Basically, inflation is how much your money can buy in terms of goods and services. It’s the amount of purchasing power you have over time. As inflation rises, the value of the currency you’re using goes down as does your purchasing power. For example, in 1940 a car would cost you $800. Let’s say the car is a brand-new vehicle. The average new car price is roughly $34,000. You’re not buying the exact same car due to technological advancements and the additional features that cars in the 1940’s did not have, but over 70 years of inflation is also factored into the difference in selling price.
As you can see, inflation ties into the prices of everything available for purchase. Essentially, the result is an increase in prices. But, what goes down can also go up. Deflation has the opposite effect on currency valuation. This means that your purchasing power increases, and you’re able to buy more for the same amount of money. The trend, however, is towards inflation. You can buffer yourself against the impact of inflation on your savings.
Diversification of investments in your investment portfolio is a key feature of successfully countering inflation. The focus here is on appreciable assets such as purchasing a home or land. These investment types tend to offset the power of inflation because, over time, they increase in real value. The emphasis here is “real value”, meaning not an artificially inflated valuation that occurs in an economic bubble.
For instance, the financial crisis that occurred in 2007 and 2008 was due to an overvaluation of homes. There were many moving parts to this that won’t be discussed here; however, the housing bubble and the ensuing drop in home prices, which was partly due to widespread foreclosures, is a prime example of artificial valuations.
Supply and demand are also significant factors in determining the value of a home. Currently in many U.S. cities, and particularly within the larger metropolitan areas, the demand is exceeding the available supply. This prompts an increase in prices.
The main point being made here is that homeownership is one of the best methods for lessening the impact of inflation. But it takes time as you gradually build equity through paying your mortgage. It’s true that most people need to save cash for the down payment, and this circles back around to keeping an eye on inflation since a 1% interest rate on your savings account is wiped away by the current inflation rate. If you have credit card or other non-collateralized debt, this can compound the inflation issue, as the annual percentage rate you pay greatly exceeds the inflation rate.
In essence, you’re losing a great deal of money via loans and credit cards. This is not inclusive of mortgages since you’re building equity, which tends to appreciate at a faster rate than inflation.
In terms of other financial investing instruments, such as commodities or stocks, you can also counterbalance inflation through a well-constructed investment portfolio. The caution here is that financial markets are more volatile than the housing market. Also, there’s a learning curve if you choose to make these investments on your own. Fees and taxes are an additional consideration for buying and selling these investment classes.
This isn’t meant to deter you, rather the goal is to give you a broader perspective regarding which assets are more likely to counteract a devaluation of your purchasing power.
Inflation is a reality all consumers and sellers must grapple with, whether they’re trying to accumulate wealth or save for retirement. If you’re a low-risk investor and you’re currently saving for a down payment on a home, paying off your credit card debt or other non-secured loans is a step in the right direction. Ultimately, buying a home is one of the best methods for getting ahead of the inflation game.