How Inflation Affects Our Savings & Our Lives
For the past few months, we’ve heard a lot in the news about increasing living costs. The cost of our essential goods and services – from our food to our electricity bills, housing, and electronics – is constantly rising. And our salary increases (if any) aren’t enough to cover the increasing cost of our basic expenses.
I wanted to write this article for several reasons. I’m not trying to paint a gloomy picture, but rather to help people better understand the situation and how increasing prices affect our lives. So, as trivial as it may sound, let’s start with the basics and the basic definition of inflation.
What Is Inflation?
Inflation is the decline of the purchasing power of a currency over time measured amongst a pre-selected basket of goods. Now, here’s where it gets more interesting.
The root cause of inflation is an increase in the supply of money in an economy. Our local monetary authorities (Central Banks and Governments) can increase the money supply, either by printing and giving away more money to individuals, by legally devaluing the currency, or by loaning new money into existence and purchasing government bonds from banks on the secondary market.
In all such cases, the supply of money increases. Thus, your living expenses increase, your purchasing power decreases, and you get less for your money. There are some exceptions to this – but we will get into that a bit later when we look at possible solutions to this phenomenon.
So, now, let’s review what we’ve seen for the past year, how inflation has affected our lives, and what our governments and central banks have done about it.
What Are Governments Doing?
Europe – The EU member countries agreed on a Pandemic Emergency Program. It’s designed to support the economies of member countries, and it’s worth 1.8 trillion euros. That’s a little over 2 trillion dollars.
America – The US has several programs designed to help its economy. The first was a 3 trillion dollar program designed to help the US overcome the difficulties of the COVID19 pandemic. There are also several other programs going to the Senate for approval, all of which will further fuel the current inflationary cycle.
What Level Of Inflation Are We Currently Experiencing?
Well, this is a great question. It’s also a bit tough to answer. You might think that the easiest way to measure price increases is by comparing prices at the grocery store, at the petrol station, or with your landlords. And that makes sense. But you might not all see the same level of inflation from one item to the next. This is because the official inflation figures are calculated slightly differently, and they’re based on a so-called basket of goods.
In the US, this “basket of goods” is managed by the Central Statistical Office. They decide what items to include in the basket and how often to change them. So, when the US inflation was calculated at 7.00% last week (the highest recorded rate in the last four decades), this was based on that specific basket of goods. That said, we’re seeing sharp increases in the official inflation data in many countries – with the UK hitting 5.40%, 5.70% for Germany, and 36% for Turkey. This means, regardless of each country’s chosen ‘baskets’, consumers worldwide are experiencing sharp measurable price increases.
The more we get into the new year, the more we find ourselves asking when this vicious cycle will end. Experts are yet to agree on what kind of inflation we’ll see in the months ahead. However, the one thing that they all seem to agree on is that inflation is here to stay for the next two to five years.
What Can We Do To Protect Our Savings And Plan For A Better Financial Future?
There are a few options that you can consider. For those of you who prefer to take a more traditional approach towards money, well, these options might not be for you. But let’s explore all the options available to you, regardless of your age:
1 – Savings accounts
If this has worked for you previously, I’m sorry to tell you that it might not work this time. Unfortunately, putting your money in a savings account is unlikely to be your best option when it comes to protecting your savings and your hard-earned money.
This is because of the meagre interest rates on offer. When measured against the official inflation figures, with a 1% interest rate, you are still likely to be losing at least 4% – 5% of your actual purchasing power. While the official inflation figures might be around 7%, the level of inflation for your specific purchases could be as high as 12% to 15%. For simplicity of calculation, let’s look at an example. Say you had 100,000 USD or EUR in a savings account with your favourite bank, you would be making a whopping 1,000 USD or EUR in interest in a year (that’s assuming you are lucky enough to get a 1% interest rate from your bank). With inflation ranging between 12% to 15%, this means that you will be down between 11% to 14%. That’s a loss of about 11,000 to 14,000 USD or EUR per year. You won’t see that reflected in your bank account as numbers, but you will feel it when you go out to purchase goods. And let’s not forget that we are entering the 2nd year of high inflation – and that means twice the potential loss in buying power.
2 – Real estate
In my country, we have a saying that if a person doesn’t know what to do with their money, they put it into real estate. It might still be a good choice; it depends on how you look at money. But with real estate returning between 7% -8% gross per year and with rising maintenance costs, it still might not make up for the 12%-15% increase in inflation. You might help to make a complete evaluation – one that factors in increasing prices and that factors in the size of your investment. If there is further inflation, or if you find yourself in sudden need of money, you may find yourself selling at a less than ideal price. Again, this doesn’t mean that real estate isn’t a good investment; it can be, based on your financial goals and investment horizon.
Another thing to consider when evaluating your investment options is your purchasing power. It might help to compare the purchasing power of your investment now with the possible increase in the price of the property in the future. It might also help to keep in mind that if inflation goes up by 20% over three years, for example, then your property will need to go up by more than 20% in value for you to benefit from the investment.
3 – Bonds
The FED is on track to raise interest rates in 2022. So, could government bonds be the way forward? 10Y US Treasuries are often considered the benchmark for a risk-free investment. That said, they don’t usually bring high returns. Let’s assume that, in a best-case scenario, you get the kind of high annual return we saw at the beginning of the century (5%-6%). Unfortunately, it still wouldn’t be enough to beat inflation and increase your overall purchasing power.
4 – Precious Metals
Precious metals, in particular gold, have always been considered a great way to protect against inflation. One thing to consider: the financial markets haven’t been reacting very well recently to the idea of the Federal Reserve keeping a hawkish mood for the next year to come. In recent years, we have noticed how the inverse correlation between the stock market and gold has partially vanished during “cold” periods of general selloff. To avoid getting liquidated on their positions on stocks, big players would rather start selling massively their positions on assets where they have gained substantial profits, as it could be on gold. The result: massive drops also on the precious metal. This means that the old-fashioned hedge against inflation might have severe volatility in price during a bear market.
5 – Cryptocurrencies
Cryptocurrencies are considered the new store of value. They have recently been compared to precious metals and sometimes been referred to as digital gold, especially when we talk about the king of cryptos – Bitcoin. Bitcoin has proven to be a great store of value, providing stellar performances in the past years, closing 2021 with +57%. Investors who have been able to jump on crypto projects at early stages have been able to get stellar returns in the sphere of 3 to 4 digits percentage. The only tiny issue with cryptos is that they require a cold-blooded investor, being able to “hodl” during periods like the current one, where they have been losing across the board more than 50% of the picks. It’s an investment that requires a very high appetite for risk.
Be sure to take a look at our blog for more content. And don’t miss out on our free webinars. Next up: “How to protect your crypto investment against adverse market movements”.
I wanted to write this article for several reasons. I’m not trying to paint a gloomy picture, but rather to help people better understand the situation and how increasing prices affect our lives. So, as trivial as it may sound, let’s start with the basics and the basic definition of inflation.
What Is Inflation?
Inflation is the decline of the purchasing power of a currency over time measured amongst a pre-selected basket of goods. Now, here’s where it gets more interesting.
The root cause of inflation is an increase in the supply of money in an economy. Our local monetary authorities (Central Banks and Governments) can increase the money supply, either by printing and giving away more money to individuals, by legally devaluing the currency, or by loaning new money into existence and purchasing government bonds from banks on the secondary market.
In all such cases, the supply of money increases. Thus, your living expenses increase, your purchasing power decreases, and you get less for your money. There are some exceptions to this – but we will get into that a bit later when we look at possible solutions to this phenomenon.
So, now, let’s review what we’ve seen for the past year, how inflation has affected our lives, and what our governments and central banks have done about it.
What Are Governments Doing?
Europe – The EU member countries agreed on a Pandemic Emergency Program. It’s designed to support the economies of member countries, and it’s worth 1.8 trillion euros. That’s a little over 2 trillion dollars.
America – The US has several programs designed to help its economy. The first was a 3 trillion dollar program designed to help the US overcome the difficulties of the COVID19 pandemic. There are also several other programs going to the Senate for approval, all of which will further fuel the current inflationary cycle.
What Level Of Inflation Are We Currently Experiencing?
Well, this is a great question. It’s also a bit tough to answer. You might think that the easiest way to measure price increases is by comparing prices at the grocery store, at the petrol station, or with your landlords. And that makes sense. But you might not all see the same level of inflation from one item to the next. This is because the official inflation figures are calculated slightly differently, and they’re based on a so-called basket of goods.
In the US, this “basket of goods” is managed by the Central Statistical Office. They decide what items to include in the basket and how often to change them. So, when the US inflation was calculated at 7.00% last week (the highest recorded rate in the last four decades), this was based on that specific basket of goods. That said, we’re seeing sharp increases in the official inflation data in many countries – with the UK hitting 5.40%, 5.70% for Germany, and 36% for Turkey. This means, regardless of each country’s chosen ‘baskets’, consumers worldwide are experiencing sharp measurable price increases.
The more we get into the new year, the more we find ourselves asking when this vicious cycle will end. Experts are yet to agree on what kind of inflation we’ll see in the months ahead. However, the one thing that they all seem to agree on is that inflation is here to stay for the next two to five years.
What Can We Do To Protect Our Savings And Plan For A Better Financial Future?
There are a few options that you can consider. For those of you who prefer to take a more traditional approach towards money, well, these options might not be for you. But let’s explore all the options available to you, regardless of your age:
1 – Savings accounts
If this has worked for you previously, I’m sorry to tell you that it might not work this time. Unfortunately, putting your money in a savings account is unlikely to be your best option when it comes to protecting your savings and your hard-earned money.
This is because of the meagre interest rates on offer. When measured against the official inflation figures, with a 1% interest rate, you are still likely to be losing at least 4% – 5% of your actual purchasing power. While the official inflation figures might be around 7%, the level of inflation for your specific purchases could be as high as 12% to 15%. For simplicity of calculation, let’s look at an example. Say you had 100,000 USD or EUR in a savings account with your favourite bank, you would be making a whopping 1,000 USD or EUR in interest in a year (that’s assuming you are lucky enough to get a 1% interest rate from your bank). With inflation ranging between 12% to 15%, this means that you will be down between 11% to 14%. That’s a loss of about 11,000 to 14,000 USD or EUR per year. You won’t see that reflected in your bank account as numbers, but you will feel it when you go out to purchase goods. And let’s not forget that we are entering the 2nd year of high inflation – and that means twice the potential loss in buying power.
2 – Real estate
In my country, we have a saying that if a person doesn’t know what to do with their money, they put it into real estate. It might still be a good choice; it depends on how you look at money. But with real estate returning between 7% -8% gross per year and with rising maintenance costs, it still might not make up for the 12%-15% increase in inflation. You might help to make a complete evaluation – one that factors in increasing prices and that factors in the size of your investment. If there is further inflation, or if you find yourself in sudden need of money, you may find yourself selling at a less than ideal price. Again, this doesn’t mean that real estate isn’t a good investment; it can be, based on your financial goals and investment horizon.
Another thing to consider when evaluating your investment options is your purchasing power. It might help to compare the purchasing power of your investment now with the possible increase in the price of the property in the future. It might also help to keep in mind that if inflation goes up by 20% over three years, for example, then your property will need to go up by more than 20% in value for you to benefit from the investment.
3 – Bonds
The FED is on track to raise interest rates in 2022. So, could government bonds be the way forward? 10Y US Treasuries are often considered the benchmark for a risk-free investment. That said, they don’t usually bring high returns. Let’s assume that, in a best-case scenario, you get the kind of high annual return we saw at the beginning of the century (5%-6%). Unfortunately, it still wouldn’t be enough to beat inflation and increase your overall purchasing power.
4 – Precious Metals
Precious metals, in particular gold, have always been considered a great way to protect against inflation. One thing to consider: the financial markets haven’t been reacting very well recently to the idea of the Federal Reserve keeping a hawkish mood for the next year to come. In recent years, we have noticed how the inverse correlation between the stock market and gold has partially vanished during “cold” periods of general selloff. To avoid getting liquidated on their positions on stocks, big players would rather start selling massively their positions on assets where they have gained substantial profits, as it could be on gold. The result: massive drops also on the precious metal. This means that the old-fashioned hedge against inflation might have severe volatility in price during a bear market.
5 – Cryptocurrencies
Cryptocurrencies are considered the new store of value. They have recently been compared to precious metals and sometimes been referred to as digital gold, especially when we talk about the king of cryptos – Bitcoin. Bitcoin has proven to be a great store of value, providing stellar performances in the past years, closing 2021 with +57%. Investors who have been able to jump on crypto projects at early stages have been able to get stellar returns in the sphere of 3 to 4 digits percentage. The only tiny issue with cryptos is that they require a cold-blooded investor, being able to “hodl” during periods like the current one, where they have been losing across the board more than 50% of the picks. It’s an investment that requires a very high appetite for risk.
Be sure to take a look at our blog for more content. And don’t miss out on our free webinars. Next up: “How to protect your crypto investment against adverse market movements”.
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.