Learn how to beat inflation. Inflation is a monster that secretly eats away your savings. And most people do not even know about it. They may never realise that there hard-earned savings become smaller and smaller each year as numbers can be deceiving.
Luckily, it is quite easy to protect yourself from inflation. With some simple tricks, you will not only beat inflation, but you can also grow your savings.
Table of Contents
How to beat inflation
What is inflation?
Wikipedia describes inflation as
a general rise in price level relative to available goods resulting in a substantial and continuing drop purchasing power in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.
But what does this mean? In simpler terms, every year, prices increase but your money stays the same. Thus, your money loses value. A fixed amount of money can buy you less and less every year.
Let us say in 2011, you buy two apples for £0.50 and each year, prices rise by 2% (an inflation rate of 2%). Ten years later, you will have to pay a lot more for your apple:
|Year||Price for two apples|
Therefore, you have to spend more and more money to buy two apples. Over time, this leads to a substantial increase in prices.
The 2% target
However, in reality, you will know that apples have not increased in price since 2019. And even in the years before, prices did not regularly increase by 2%. Instead, they may have increased a lot in some years, and not at all in other years. This is because, in reality, 2% is merely a target.
Why do we have a target of 2% inflation? Personally, I would prefer 0% as that would mean my money would always have the same value and prices would not increase. However, the Bank of England and, in fact, probably every other bank in this world, do not agree with me. They say a stable rate of inflation is more desirable because:
- A low inflation rate may mean that people spend less because they expect prices to fall. If nobody spends, many jobs will be at risk
- If inflation is too high, money loses its value too quickly. Consequently, the economy would slow down and many will be left unemployed
- A highly fluctuating inflation rate means that businesses cannot plan ahead and have difficulty with setting the right prices
However, as you may know from experience, we do not always meet the 2% target. In fact, we hardly ever do. A margin of 1% on either side is considered acceptable, so inflation should range from 1-3% every year. Here is what it looked like in the past 20 years:
Next, let us look at the two apples we bought in 2011 for £1. Since then, their price has changed as follows:
|Year||Price for two apples|
The effect of inflation on your savings
We have talked about how inflation influenced prices. But that is not all; your savings are also affected. As prices increase every year, your money loses value because you can buy less with it. Thus, your money is less worth, even though the numbers in your savings account will still be the same.
For example, let us assumed you left £100 in your current account with 0% interest.
|Year||Actual amount||Real value (2% inflation)||Real value (actual inflation)|
As the table above shows, your money has lost value and are only worth £86 in 2020. If the UK had reached the target inflation rate of 2% every year, you would have lost even more and only have £83 left. Note that your actual account balance is still has not changed. What has changed is the relative value of your money compared to 2011.
How to beat inflation
Before you empty your bank account, let me tell you that there is a way to protect yourself from losing money due to inflation. You may think that spending your money is a good counter-measure. However, the goods you buy with your money are also likely to lose value and depreciate.
There are a few options for you if you want to beat inflation:
- Buy goods or object that increase in value by more than 2%, for example properties
- Put your money into high-interest current or savings account (more than 2%)
- Invest in stocks or funds that return more than 2%
Essentially, as long as your money returns 2% consistently, you are safe. In some years, the rate of inflation will be higher than 2% (as you can see from the above graph). However, in other years, it will also be lower. Therefore, if you have a consistent return of 2% or more, you should not lose money over time.
How to beat inflation summary
Inflation means your money loses value over time because prices rise every year. Thus, your savings also lose value, in line with the inflation rate. Although the target inflation rate is 2%, the actual value varies every year.
You can protect your money from inflation by investing your money so that it returns consistently more than 2%. This can be achieved through high-interest savings accounts, stocks or objects such as property.
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