Inflation and its effects on your savings

Wondering how to protect your savings from inflation? Start here.

You’ve finally saved up for your dream vacation. But as you begin to book your flight and hotel, you realize that today’s prices are much higher than they were when you started saving. Or maybe you’ve been pinching pennies for a home improvement project, and your contractor informs you that the estimate has increased. Maybe it’s a down payment for a home that you’ve been saving for years to afford, which is suddenly several more years out of reach.

What’s going on? Why is everything getting more expensive?

The answer: inflation.

What is inflation?

“Inflation is really a measure of how the prices of goods and services in the economy are changing,” says Ryan Chahrour, an associate professor of economics. For instance, when the price of milk increases, that’s a sign of inflation, he adds. The same goes for price hikes on haircuts and gasoline.

When prices go up, your dollar doesn’t stretch as far, according to Jeff Rose, CFP®, founder of the website GoodFinancialCents.

He explains that although the amount of money you have stays the same, it doesn’t pay for as much food, groceries, and gas, or as many utility bills as it used to.

For example, let’s say that a gallon of milk cost $2 last year, but now it costs $3. That means that last year, a dollar would get you half a gallon of milk. But today, thanks to inflation, a dollar only gets you one-third of a gallon.

In other words, inflation diminishes your buying power, and it has been chipping away at it for a long time. As you consider inflation and its effects on your savings, keep in mind that inflation is nothing new. The U.S. has experienced periods of inflation throughout the country’s history.

As inflation accelerates, learn how it impacts the money in your savings.

Within every inflationary period, Americans have had to confront the relationship between inflation and savings. As the buying power of money declines, tough questions arise: How does inflation affect savings? Do savings interest rates rise with inflation? How does inflation affect retirement?  

The financial experts offer their answers to those questions, and they also have some tips that can help you protect and grow your savings even while inflation is on the rise.

How does inflation impact the money in your savings?

Inflation is no picnic for the savers out there.

“Since inflation means that prices are generally going up, it also means your savings—unless it’s somehow protected against inflation—is able to buy fewer things for you,” Chahrour says.

So, do savings interest rates rise with inflation? Chahrour says that they typically do because the Fed is likely to raise rates to combat the inflationary trend. When this happens, the interest rates in savings accounts tend to increase as well. However, Chahrour notes that even when savings interest rates do rise with inflation, they don’t always keep pace.

The diminishing buying power of your money and the increases in interest rates that tend to follow can complicate how you reach your savings goals, Rose notes.

“Over the last 40 years inflation has averaged around 3.8%,” he says. “When inflation is higher and, concurrently, so is the price of goods, that will affect both short-term and long-term savings goals.”

Whether you use multiple savings accounts for short-, medium-, and long-term goals or not, you’re probably wondering how inflation could impact how much you should save each month to hit your goals. Allow the experts to provide the context you need to decide what makes sense for your situation.

“Over the last 40 years inflation has averaged around 3.8%. When inflation is higher and, concurrently, so is the price of goods, that will affect both short-term and long-term savings goals.”

Jeff Rose, CFP®, founder of Good Financial Cents

Vacations and inflation: How does inflation impact short-term savings goals?

Rose notes that inflation can seriously disrupt short-term savings goals because the higher prices are felt immediately. “Consumers will feel it more in the short term because it’s right now, not 10 to 20 years from now,” he says.

When inflation hits, the amount you saved for your short-term savings goals—those that take three or fewer years to reach, like upcoming vacations and holiday gift purchases—can suddenly become inadequate.

“If prices are rising but your income hasn’t caught up, you may find that you can’t take that vacation you were hoping to take,” Chahrour says.

As a result, you may need to recalculate your savings goal to reflect the new, inflated costs. Then, break down the difference into regular, manageable chunks of savings until you hit your new goal.

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With prices rising, you might also find that you need to add to your emergency fund to cover any increases in the cost of your living expenses, such as utilities or groceries. Keep in mind that your rainy day fund should be able to cover anywhere from three to 12 months of living expenses if you were to lose your primary source of income, says Rose. While you’re at it, you should also make sure you’ve stored that money in one of the best places to keep emergency funds: a high-yield savings account, money market account, CD account, or IRA (if you’re retired).

Homebuying and inflation: How does inflation impact medium-term savings goals?

When it comes to medium-term savings goals—those that take three or more years to reach, such as a down payment on a house—you might find that you need to save extra to achieve your goals. 

Making things more difficult is the fact that you’re paying more for everyday items like gas and groceries. That means that there’s less remaining in your paycheck to contribute to your goals that are more than three years out. 

“You may need to be a little more patient,” Chahrour says. “If you can’t afford it, you may need to change your target a little bit, too—to adjust to the situation.”

In 2022, home prices soared as supply couldn’t keep up with demand. Many would-be homebuyers were priced out of the market, but Chahrour notes that buying a home can be an effective hedge against inflation.

If you get a 30-year fixed rate mortgage and inflation goes up, that fixed-rate mortgage doesn’t change, Chahrour says. “Rents might go up, but your mortgage payment doesn’t change.”

Retirement and inflation: How does inflation affect long-term savings goals?

No one can predict how long a period of high inflation will last, so it’s hard to make guesses about the impact on long-term savings goals that can take decades to reach, like saving for college or retirement. If you’re wondering, “How does inflation affect retirement?” the answer is that it depends.

“Most of the kinds of long-term savings that people do for retirement, say in the stock market, are fairly well-protected against inflation because if we see high inflation, we see higher price levels,” Chahrour says. “We would expect stock prices to eventually adjust to those levels as well.” In other words, he says, prices and profits often rise together.

Still, it’s not a bad idea to do some growth calculations, says Rose, especially for retirees who have concerns about how inflation can affect their portfolios during retirement. As you’re figuring out how to account for inflation in retirement planning, Rose recommends bumping up your estimates for inflation when using a retirement calculator or retirement planning software. 

“Most financial planning software will use 3%-4% as the baseline for inflation,” he says. “Increasing those inflation numbers to 5%-6% or more will reveal how much that truly affects your portfolio while taking distributions for your monthly living expenses in retirement.”

Running those inflation and retirement numbers can help you see if you need to invest more aggressively or live on less, according to Rose.

You should also keep in mind that inflation risk in retirement is something else to consider when it comes to retirement planning. For example, you’ll want to learn how different interest rates affect retirement plans or how to think about longevity risk (the idea that you could live beyond your retirement savings). 

Here are tips and strategies for how to protect your savings from inflation.

Do you know how to protect your savings from inflation?

Now that you know how inflation affects savings, you might want to learn some tips and strategies for safeguarding your savings. Although it’s best to check with your financial advisor to determine the best way to protect your savings from inflation, Chahrour and Rose offer a few ideas to get you started:

Put your money in a high-yield savings account

Putting your money in a savings account with a competitive interest rate can help protect your money against inflation. Although the annual percentage yield can’t always keep up with unpredictable inflationary spikes, it can help counteract the loss of purchasing power that inflation brings.

Invest in real estate

“Financing a house is actually a great way to protect yourself against inflation,” Chahrour says. He adds that while monthly rent can go up during periods of high inflation, a fixed-rate mortgage doesn’t change.

Look into Treasury Inflation Protected Securities (TIPS)

The principal of these securities, also issued by the U.S. government, rises with inflation (and falls with deflation), which helps protect against wild inflationary swings. “You’ll be very sad to see the interest rates on those, but they will protect you against inflation,” Chahrour says.

Check out the Series I savings bond

A lesser-known option, Chahrour says, is the Series I savings bond, which is a low-risk, government-issued savings bond. Chahrour explains that the Series I is an interesting saving bond where the interest rate is equal to the current inflation rate. Chahrour points out that unlike TIPS, which don’t have a limit on how much you can buy, one can only buy up to $10,000 of Series I bonds each year.

Invest in the stock market

For long-term savings goals, you might consider stocks, exchange-traded funds, and index funds in the market—even if the latest charts don’t look encouraging. “If you look at one of the most common inflation hedges that will help you keep up with inflation, it’s the stock market,” Rose says.

Chahrour offers a more cautionary stance: “I’m an economic theorist by day, and some theories would imply stocks are great protection against inflation; others would imply that they’re not. Recent stock market declines could be evidence against stocks being an inflation hedge. But what happens over the coming three, five, or 10 years of course remains to be seen.”  

Open or add to 401(k) and IRAs

If you’re not already saving for retirement, you should consider opening a retirement account and saving your funds in a 401(k) or IRA. Although your retirement investments may not outpace the high inflation in the short term, over the course of a decade or two they typically perform well (if you still have some time to invest).

The one strategy you probably don’t want to employ: hiding your money away at home.

“Cash under the mattress is the worst when it comes to inflation because you get no compensation ever,” Chahrour says. In other words, keeping cash at home won’t earn you any interest.

Inflation and savings: How can you save extra money during inflation?

As you consider inflation and its effects on your savings, you might want to do more than protect your savings—you might want to add to them. Taking a hard look at your finances is the best way to get started, Rose says.

“Start identifying the areas that you could cut back on or need to cut back on,” Rose says. Obvious areas to look are less-used streaming subscriptions, grocery, or meal delivery services—conveniences that you might’ve added during the pandemic.

One of the best money-saving hacks is cost-cutting. When considering items to cut out of the budget, Rose recommends asking yourself the question: “Do we really need that?”

If you’re concerned with inflation and savings, identify areas where you can save extra money.

To stay ahead of inflation, Rose says that some consumers are buying ahead to save money in the long run. For instance, if they know that they’re going to need to replace their refrigerator in the near future (and they think inflation will continue to rise), they’ll go ahead and make that purchase now. If they know their kids are going to need the next size up in winter coats, they might buy those now.

If you are going to make any advance purchases, Rose says to make sure they don’t detract from your emergency fund or current needs.

“Inflation really forces the consumer to think ahead,” Rose says.

Need help? Managing inflation and its effects on your savings might require a professional

You might need more help to find your financial footing as you’re considering inflation and its effects on your savings. Rose suggests reaching out to a professional, even one who takes clients on an hourly basis, who can offer advice unique to your financial situation.

“Just as you’d see a doctor for an annual checkup, you might want to see a financial planner who can tell you if you’re okay or if there are any glaring issues,” Rose says.

During periods of high inflation, the news headlines and stock market swings can feel alarming. But a little bit of knowledge and a few smart strategies will go a long way to helping you weather inflationary spikes.

Now that you know how inflation affects your savings, take some time to learn about how multiple savings accounts can help you keep your savings goals on track—even during periods of high inflation.

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