Inflation happens when money loses its purchasing power. As a result, the prices of goods and services increase, making you spend more for the same standard of living. Currently, inflation is pretty high. But luckily, there are some actions you can take to minimize inflation’s effects and even potentially outpace it. In this article, we’ll explain what causes inflation and dive into some ways you can combat it to preserve the value of your savings.
Causes of inflation
Inflation occurs when your money loses value. There are three main causes of inflation:
Demand-pull inflation happens when demand far exceeds supply. Since a lot of people want a limited supply of goods, the producers of those goods raise prices. For example, if gas is in short supply and people start driving more, prices will rise.
Cost-push inflation happens when the prices of materials and labor needed to make products increase. This makes the product more expensive to create. As a result, the producers must raise their prices to keep the same profit margins. For instance, if the prices of beef, bread, and condiments increase, burgers will get more expensive.
Monetary inflation is when the Federal Reserve increases the number of dollars in the economy. When there are more dollars circulating through the economy, each one is worth less. As a result, it takes more dollars to purchase the same number of goods.
Imagine you and 9 other people each have $1. Then, you each get paid $99 more, so everyone has $100. Now, everyone values each dollar less. Since $1 is a smaller portion of everyone’s money, they’re more willing to spend it. As a result, the product in this situation would raise their prices.
Ways to combat inflation
Inflation can slowly erode the value of your dollar. But fortunately, there are a few ways to fight it and preserve your money. Follow these tips to reduce the effects of inflation:
Make a budget
First, create a budget. This helps you stay on top of your expenses and prevent overspending. Plus, you can identify expenses you don’t need and cut them out, which can save you more money you can set aside in a savings account or invest.
Save money wisely
Saving money helps you prepare for future financial problems by ensuring you have several months of expenses safely in a bank account. However, saving money on its own may not help if your savings account interest rate is small. Your money will still lose value if your savings interest rate is lower than inflation.
For example, if inflation is 3% per year, but you’re only earning an APY of 0.05%, your money is losing a net amount of 2.95% each year. Consider a high-yield savings account. The rates on these accounts are much higher than traditional savings accounts, helping you to reduce the effects of inflation and sometimes even outgrow it.
Invest your money
A great way to stay ahead of inflation is to invest it wisely. The stock market can generally grow much faster than inflation, helping you grow your wealth regardless. For example, if you can earn an 8% average return in the market and inflation is 5%, you’re still growing by 3% each year.
That said, you risk losing money in the markets as well. That’s why it’s important to know how much risk you can tolerate and when you need the money. Working with a financial planner can help you pick investments based on your situation and goals.
The bottom line
Inflation can happen for several reasons, and demand-pull, cost push, and monetary inflation are all contributing to high inflation rates at this moment. Fortunately, you can stay ahead of inflation by making and sticking to a budget, saving money in the right savings account, and investing wisely. Ultimately, working with a financial professional can help you create a plan to preserve your money and stay ahead of inflation.
Notice: Information provided in this article is for information purposes only. Consult your financial advisor about your financial circumstances.