How Does Inflation Affect Savings?

Have you noticed that the cost of just about everything seems to have gone up lately? Inflation is often the driving force behind these price increases. As inflation rises, the purchasing power of the dollar can shrink. Not only does this affect everyday purchases, it also erodes the value of savings, potentially making it harder to reach financial goals.   

Understanding Inflation and How It Affects Savings

Inflation is the rate at which the general level of prices for goods and services increases over time. For example, if inflation is at 2%, it means that, on average, prices have increased by 2% compared to the previous year.

When prices go up, money has less purchasing power. If a carton of eggs cost $3.00 two years ago and $5.50 today, the same amount of money now buys fewer eggs.

But how does inflation affect savings? The same principle applies. Even though the amount of money in a savings account might increase or stay the same, its real value decreases over time if the interest earned doesn’t keep pace with inflation. Consider an account that earns 1% interest. If inflation rises by 3%, the account actually experiences a 2% loss of purchasing power. So, while the balance may appear to grow, the money in the account buys less over time, making it harder to reach long-term financial goals.  

Financial Planning for Inflationary Periods                                                             

With the right financial planning, it’s possible to minimize the effects of inflation on a savings plan. Knowing where to place savings and how to adjust strategies may help protect funds against rising prices. 

Choosing the Right Savings Accounts

There are several different types of savings accounts to choose from, and some may prove more effective than others in a high-inflation economy. Each has its own benefits, making it important to find one that suits your financial goals. Here are a few options to consider: 

• Traditional savings account: Provides a secure and easy way to access and store money but typically pays lower interest rates compared to other savings options.
• High-yield savings account: Provides higher interest rates than traditional savings but may have minimum balance requirements and may limit the number of fee-free monthly transactions.
• Money market account: Combines features of savings and checking accounts. Money market accounts offer competitive interest rates and often come with an ATM/debit card. Some may also offer check writing.
• Certificate of deposit (CDs): Locks in a fixed interest rate for a set term, offering stable returns in exchange for leaving the money untouched until the maturity date.

Strategies for Inflation-Proofing Your Savings

In periods of high inflation, traditional savings accounts may struggle to keep up with the pace of rising costs. High-yield savings accounts may offer a better option, as their higher interest rates may help offset some of the loss in purchasing power. Money market accounts may also be useful, as they tend to provide more competitive rates while still offering easy access to the funds.

Certificates of deposit can lock in a fixed rate, which could prove a disadvantage if interest rates are expected to keep rising. In this case, the fixed rate on the CD would remain the same, even as other savings accounts begin offering higher rates. While a CD may provide stability by offering a guaranteed return, it may result in a lower real return compared to other options that can adjust with changing interest rates. However, purchasing a CD when interest rates have peaked may allow you to lock in a relatively higher rate for a set term.

Diversify Your Investments

You may consider diversifying beyond savings accounts. Spreading money across different asset classes like stocks, bonds, real estate, and commodities often helps balance the risk of inflation. For example, stocks and real estate often appreciate over time and may outpace inflation, potentially making them valuable parts of a well-rounded portfolio.

Securing Your Financial Future Amid Inflation

As inflation rates and economic conditions change, it’s important to evaluate investment choices and make adjustments as needed. Keeping an eye on real interest rates (the difference between the nominal interest rate and inflation) can help identify which investments are providing positive returns after accounting for inflation.

As you seek solutions that align with your current needs and long-term goals, consider PNC Bank’s suite of savings tools. Explore your options now or connect with our team for a personal recommendation.

Frequently Asked Questions

How can I protect my savings from inflation?

One way you may be able to protect savings from inflation is to look for savings accounts that pay an annual percentage yield (APY) higher than the current inflation rate. High-yield savings accounts or money market accounts may offer competitive rates. If savings rates fall short, consider diversifying into other investments that may offer better long-term growth. You can also prepare for inflation by creating and sticking to a budget, building up an emergency fund, and proactively adjusting strategies for the current economic conditions.

Is it bad to save money during inflation?

It’s not necessarily bad to save money during inflation, but it’s important to recognize that cash savings may lose value if the interest earned doesn’t keep pace with rising prices. While having an emergency fund is always wise, it may be better to balance savings with investments that have the potential to grow and outpace inflation. This approach may help maintain purchasing power while also keeping cash on hand for unexpected expenses.

What are common misconceptions about inflation and its effects?

It’s a common misconception that all savings will lose value equally during inflation. In reality, the effects vary depending on where money is kept. For example, while traditional savings accounts may lag, a high-yield savings account may likely fare better.

Another misconception is that high inflation always leads to economic instability. While inflation can increase costs, a moderate level of inflation is often a sign of a growing economy. Understanding how different financial tools interact with inflation may help you make better decisions about managing money during such periods.