How Inflation Affects Your Savings: What You Need to Know

Savings accounts are tricky to navigate when prices are rising. Here’s how inflation affects your savings and what you can do to protect your hard-earned dollars.

Price increases on goods and services have surged in the United States, with inflation rising by 6.8% in November 2021 compared to a year earlier. This means that even as wages increase, our buying power arguably declines.

On a basic level, inflation affects your savings because you’ll need more money to make purchases than you did in previous years, or even months.

But inflation’s effect on your savings isn’t all about math. Here are some key ways it can hit your wallet hard, plus what you can do about it.

1. CDs and savings accounts may not keep up with inflation.

Typical savings vehicles such as certificates of deposit (CDs) and savings accounts often pay interest rates that are nowhere near the pace of inflation. This means that the money you’ve stashed away in these accounts is likely to lose value over time.

For example, say you kept $1,000 in a savings account that earned 0.3% interest annually. After one year, you’d have earned just $3 in interest. And if inflation rose by, say, 5% during that year, you would have lost more than $50 in spending power.

2. Inflation can eat away at your retirement funds.

Retired people typically live on savings and investment returns drawn from retirement accounts such as IRAs and 401(k)s.

But if the interest rates they are earning are below the inflation rate, their accounts will lose buying power over time. This means their retirement funds will pay for fewer goods and services than they would have at the account-opening time.

3. Borrowing gets more expensive.

Whether you’re borrowing money for a car, a home, or your education, inflation can increase the cost of paying back your loan.

That’s because inflation increases the price of goods and services while your loan payments remain the same. This means you’re effectively paying back with dollars that have less purchasing power.

4. Real interest rates can turn negative.

The aforementioned interest rates don’t necessarily reflect the real return you get from your savings vehicles.

That’s because the Federal Reserve often raises or lowers rates to try to meet its own inflation target. Sometimes, the central bank can be slow to adjust rates to better coincide with inflation.

And when rates are raised, it can be to counteract an inflationary burst that’s already happened. In other words, the rise in rates often comes after your buying power has substantially decreased.

5. Inflation can make budgeting tougher.

Those who carefully track their spending and adhere to a budget may find their dollars don’t go as far as they’d hoped.

Even those who diligently put money into savings each month may find their progress toward meeting larger financial goals, such as buying a home or retiring at a certain age, is hindered.

6. International travelers face a tougher financial landscape.

Inflation isn’t confined to the United States. Inflation rates vary from country to country, but if you travel abroad, you’ll likely find that the rates affect the price of goods and services while you’re there.

This could make your vacation more expensive than you’d planned, or make it harder to bargain while shopping in an open-air market.

7. Some level of inflation is considered normal.

Inflation is typically considered “good” if it averages between 2% and 3% annually. That’s because it encourages consumers to spend rather than save cash, which can boost economic growth.

But any significant deviation from this range is typically described as “bad.” In reality, there’s no good inflation and it all eats away at your money.

8. You can protect your savings from inflation.

Though inflation erodes the buying power of your money over time, there are strategies to mitigate its effects.

Consider these four moves to make inflation work in your financial favor:

a. Invest in stocks or bonds

Typically, these types of investments are considered less safe than CDs or savings accounts. But they often rise in value in response to inflation.

Of course, there are no guarantees in investing. It’s possible to lose some or all of the money you’ve invested.

b. Seek out higher-yielding savings vehicles

To offset the downward pressure on your savings from inflation, consider opening an account that offers a higher interest rate.

There may be fewer consumer protections on these accounts, and they may carry some risk of loss, but they could offer a worthwhile boost to your savings’ value.

c. Invest in real estate

Investing in property typically means paying down a mortgage over time. As property values generally rise in step with inflation, your equity in the home should increase over time.

d. Create an inflation-focused portfolio

Most financial experts suggest a mix of asset classes to withstand the effects of inflation on your portfolio.

That may mean balancing your stocks and bonds with alternative investments such as real estate investment trusts, precious metals, and natural resources.

9. Financial planning during uncertain times

A financial adviser may help you navigate the complexities of inflation and develop a plan for your circumstances.

They might help you analyze your current savings and investment allocations (including any employer-sponsored retirement plans) and suggest strategies for shifting assets to hedge against inflation.

Another potentially beneficial option is working with a certified public accountant to optimize your taxes and maximize savings or investments.

10. Keep an eye on inflation news and alerts

Keeping an eye on inflation news and alerts can help you gauge how quickly prices are changing, and where you might feel the most pinch.

The U.S. Department of Labor’s Consumer Price Index, a measure of inflation, is updated monthly.

11. Prep your budget for rising prices

Inflation is particularly hard to navigate during periods of rapidly rising prices, such as during a pandemic or after a recession.

In these situations, it might make sense to create a budget that builds in potential price increases.

For example, if your grocery bill has risen by $100 per month over a year, try adjusting your monthly expenses accordingly.

12. Be prepared for higher interest rates

Higher interest rates can be a sign that inflation is heating up. If you’ve been considering borrowing money, do so while rates are still low.

Similarly, if you have existing variable-rate debt such as a credit card balance, its interest rate may increase in step with broader interest rate movements.

13. Keep your money in a high-yield savings account

If you’re stashing your emergency fund in a low-interest savings account, consider transferring the money to an account that offers a higher yield.

You may not get much advantage if inflation jumps, but it may offer some small protection against buying power losses.

14. Get insured

Protecting your family with the proper insurance policies, such as health, home, and life, can offer a financial cushion should the worst happen.

Make sure to review your policies regularly and tailor them to your needs, such as adding coverage for a new baby or new home.

Bottom line

Inflation is a complex phenomenon that can be difficult to navigate, particularly when its effects are felt internationally and domestically.

Its impact on your savings and spending habits is a serious concern, but there are strategies to help protect your money’s buying power.

These strategies include investing in a diversified portfolio, seeking higher-yielding savings vehicles, and optimizing your tax situation.

Always consult a financial professional who can provide advice tailored to your needs and risk tolerance.