What is Inflation, and How Does it Affect Me?

Inflation can affect our finances in a variety of ways, ranging from the cost of our weekly groceries to the value of our savings, but what does it really mean?

It is critical to understand how inflation works and the implications for your money management. If you are a business owner, offering workplace financial wellness measures may help your staff to get their heads around the concept. This will not only benefit their personal lives but their working lives too. 

What is Inflation?

Inflation is frequently defined as a “measure of the increase in the price of goods and services over time.” Inflation not only affects the cost of living – things like transportation, electricity, and food – but it can also affect interest rates on savings accounts, company performance, and, as a result, share prices.

As inflationary measures rise, your money’s purchasing power decreases. In other words, you now have less purchasing power because you can buy less with your money.

It is not something that we generally have any control over, but what we can do individually, both in our personal and business lives is to take steps to protect our wealth.

How Will Inflation Affect My Money?

When it comes to the cost of living, rising inflation means that maintaining our previous way of living has become more expensive. If your income has not increased by at least the rate of inflation over the measured period, your purchasing power will have decreased because the costs of goods and services have risen during that time.

Inflation affects not only our everyday expenses, but also our savings, investments, and pensions.

Cash savers may be hit particularly hard as our money’s purchasing power declines. For instance: if you put the money needed to buy a house into a bank account for five years – at a 1% annual interest rate – and the cost of houses rises by 2% per year during that time, you will need to put more money in at the end of the period to be able to buy the house.

Consider how much the cost of living has changed since you were a child. A high rate of inflation combined with a low rate of interest means that the money we have saved in potentially underperforming savings accounts could be negatively impacted, causing cash savers to suffer.

If inflation exceeds interest rates, as is usually the case, your returns will be negative in real terms, prompting you to consider whether cash is the best long-term investment. Alternative savings methods, such as investing in assets that have historically increased at a faster rate than inflation may be well worth looking at, such as property or stocks and shares.

If you are saving for retirement, it is critical that the investment performance of your funds be closely watched on a regular basis. If a fund’s performance over a reasonable time period fails to outperform the rate of inflation, alternative strategies should be considered to ensure that funds grow in real terms.