Protect Your Finances From Inflation

Protect Your Finances From Inflation

March 11, 2020

Tagged As: Personal

How to Protect Your Finances From Inflation

In 1925, the average price for a half gallon of milk in Chicago was 28 cents, and a pound of butter cost 55 cents. With those prices in mind, one trip to the grocery store today can teach you a valuable lesson about inflation, which is a general increase in prices that causes the purchasing power of money to fall.

However, looking at historical examples of inflation only tells part of the story. Many of us understand that the price of goods and services gradually rises over time – but fewer people make the connection between the force of inflation and their own finances. To put it simply: the money you currently have will be worth less next year, and even less the year after that.

Stick with us as we go over a bit of background on why inflation happens and how it works, then we’ll give you some practical advice on protecting your finances from inflation.

Why does inflation happen?

There are a few reasons why prices increase over time. One is that the cost of producing goods increases, in what’s known as cost-push inflation. This can be caused by a shortage of materials, higher wage demands from workers, and other factors. Companies then raise prices to cover the rising cost of producing their products.

The other cause is called demand-pull inflation, which happens when consumers demand more of a certain product, or when consumer spending rises across the economy. Both of these causes decrease the power of a currency relative to the good or service one can buy with it.

Deflation, the inverse of inflation, is a decrease in the price of goods. It has occurred several times throughout U.S. history, but the last period of significant deflation was after the Great Depression in the early 1930’s.

How does inflation work?

The average annual rate of inflation in the U.S. is 3.22%. That means that something which costs $100 this year will cost $103.22 next year, assuming the inflation rate holds steady. But just like how compound interest can grow your finances over time, it also increases inflation’s impact on prices over time.

Under the current inflation rate, the price of a given good doubles every 20 years. The compounding effect of inflation is even more dramatic over a longer period of time. What would cost $100 in 1918 would cost about $1700 in 2018.

In this sense, inflation is actually making you lose money over time, because you can’t buy the same products or services with the money you have. That means the old trope about keeping money under your mattress is ill-advised in more ways than one: not only is it a bad idea to keep lots of money in an unsecured location, but it’s actually losing value the longer it sits there!

How to protect your finances from inflation

Protecting your finances from inflation means generating enough additional money to outpace the inflation rate – or at least enough to make the sting of inflation less painful. There are a number of ways to do that, including both FDIC-insured and non-insured options:

  • Investing: Making shrewd investments can yield dividends far greater than the amount swallowed up by inflation. But even standard stock market investments – like buying into the top mutual funds and stock market index funds – can be a good way to receive a modest return on your investment that helps your money retain its value.
  • 401(k) contributions: Aside from investing on their own, full-time employees can take advantage of their employer’s 401(k) retirement program, which invests money on your behalf with tax breaks. The power of compound interest can serve your finances well into retirement, even with inflation.

Investment products are not a deposit, not FDIC insured, not insured by any federal government agency, carry no bank guarantee, and may go down in value.

FDIC insured: 

Savings accounts and CDs: While the interest rate on most savings accounts and certificates of deposit (CDs) is not quite as appealing as the potential gain from investments, they are also safer options that can reduce the impact of inflation on your finances, if not eliminating it entirely.

High-yield checking accounts: If you don’t have a lot of money you can tie up in investments, savings accounts, or CDs, a High Interest Checking Account can be a great way to nearly neutralize the effect of inflation on your finances, assuming you can meet the requirements to earn the highest interest rate.

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If you’d like to learn more about any of the financial options above, our bankers and wealth management professionals can help. You can start a conversation with a personal banker right now through our HERE app, or visit any of our 19 locations across Eastern Iowa.