Spencer Tierney* explains what inflation is and how to keep it from draining your short-term and long-term savings.
Photo: Blake Cheek
One million dollars might sound like enough to retire with today, but by the time you reach your last day of work, it’ll be worth less than you might think.
The reason is inflation, and it impacts how you plan for the future.
Here’s a look at what inflation is and how to keep it from draining your short and long-term savings.
Here’s what inflation is …
Broadly speaking, inflation is the increase in overall prices for goods and services in an economy.
You’ll need more money tomorrow to buy the same things you buy today.
“Inflation is the silent killer of your financial plan,” says Derek Brainard, manager of a nonprofit that helps law students understand their finances.
When putting away money for retirement, Brainard says, “you might need to be saving a lot more than you think because of inflation.”
The long-term average rate of inflation is between 2 per cent and 4 per cent annually.
So, if you kept money in a safe, it’d be worth 2 per cent to 4 per cent less per year.
… and here’s how to beat it
You can’t stop inflation, but you can make your money work better for you.
These two strategies can help:
Invest your money for retirement in superannuation.
You might not know why this matters: these accounts are your best bet for earning long-term returns that beat inflation.
For short-term savings, find a high-yield certificate of deposit.
Some online banks and credit unions have one-year CDs with annual percentage yields higher than 2 per cent and five-year CDs with APYs over 3 per cent.
“You can beat inflation by a little bit right now if you pick a good CD,” says corporate economist Robert Frick.
But keep your emergency fund separate
Investing to curb inflation’s effect is smart, but you also need savings outside of CDs and brokerage accounts to cover emergencies.
Dana Twight, a certified financial planner, says “your emergency fund’s purpose is not to beat inflation.”
Rather, it’s for easy access to money when you need it.
A regular savings account is easier to withdraw money from than a CD or investment account.
An emergency fund should cover three to six months of living expenses, but “that’s based on the costs today,” says Brainard.
“It’s important to revisit that [number] every single year.”
Inflation will likely increase those costs.
Should I worry about inflation?
A little inflation is not a bad thing.
“Around 2 per cent” is generally an acceptable rate.
And it helps stave off deflation, which is when overall prices and even wages can decline, which happened during the Great Depression.
Since the 2008 recession, inflation has been historically low.
But “there’s some sign that inflation is ticking up,” says Jim Benedict, a senior wealth strategist.
Still, “it’s certainly not out of control,” says Frick, “but it should enter into people’s decision-making when they invest long term.”
* Spencer Tierney is a personal finance writer at NerdWallet. He tweets at @SpencerNerd.
This article first appeared at www.nerdwallet.com.
