Inflation is an inevitable part of the economy, and it affects all parts of life. While a moderate amount of inflation at 2% is considered healthy for the economy, inflation higher than that can be dangerous. Known as the "silent killer," high inflation means your money doesn't go as far and can destroy your hard-earned savings.
Keeping your money in a savings account might seem like the safest option, but it can have its drawbacks. One of these drawbacks is that your money is losing value due to inflation. This means that, even if your balance stays the same, the purchasing power of your money decreases over time. With inflation currently at 40-year highs, here's how much money you are losing to inflation by keeping it locked away in a savings account.
What is inflation?
Inflation is the rate at which prices increase over time. It's calculated by comparing the current price you pay for goods and services with their prices from a previous period. As prices rise, you need more money to buy the same amount of goods or services as before. In other words, your purchasing power decreases and your money is worth less than it was before.
The impact of inflation on your savings account balance
If you have been saving money in a standard savings account, you may be surprised to learn how much value it has lost due to inflation. Inflation is currently averaging 7.1% for 2022, hitting as high as 9.1% in June. Let's say one year ago, you put $1,000 in your savings account. The average savings account is currently earning 0.30% APY, so after a year, you will have $1,003 in your account (not much!).
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But with inflation running at 7.1%, you would need $1,071 to have the same buying power that you started with. This means you actually lost $68 by your money sitting in a savings account. If, for example, inflation were to remain at 7%, in five years your $1,000 saved in a normal savings account would be worth around $700 today. This money loss would only get worse over time.
Americans have lost an average of 2.52% per year in purchasing power since the year 2000 due to inflation, resulting in a cumulative price increase of 72.89%. In other words, $100 in 2000 is equivalent in purchasing power to about $172.89 today. Let's say you bought a bike in 2000 for $100. In 2022, the exact same bike would cost close to $173. So a dollar today only buys about 60% of what it could buy back then. That means that $10,000 held over 20 years would only have about half its purchasing power left. Ouch!
How can you protect yourself from inflation risk?
If you want to protect your money from inflation, you need to invest it in something that will keep up with the rate of inflation. This can be done through buying stocks and bonds or even making real estate investments. These types of investments have the potential to earn higher returns than a standard savings account, which can help offset some of the effects of inflation.
Investing has higher risks but also higher rewards -- stocks tend to yield returns that outpace inflation over long periods of time. So investing for long-term goals (like retirement) makes sense for many people who want their money to not just stay safe but also grow faster than if they kept them in a bank account. For short-term goals, however, you can look for higher-yield savings accounts. Want returns over 7% with virtually no risk? I bonds may be the answer.
Unfortunately, keeping your money in a savings account doesn't provide nearly as much protection against inflation as other investment strategies. Due to inflation, the average Social Security beneficiary has lost close to $6,500 in annual purchasing power since 2000. It's important for savers to understand how much money they're missing out on due to inflation when keeping funds idle in bank accounts. Although inflation is an unavoidable part of economic growth, there are ways to minimize its impact on your finances. Researching different investment options can help ensure you're getting the most out of your hard-earned dollars.