Here are six reasons why inflation erodes cash and savings. Now, this is something I have been learning over the last ten years and thought to start getting this information published in snippets.
Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
Key Point: When inflation occurs, each unit of currency buys fewer goods and services.
I learnt this information later in life, and it has changed my life and how I do what I do and I truly want others to understand this fundamental information and concept – when I heard it initially, I immediately understood and thought, how have I not known that?
Well, the truth is I wasn’t in the right place with the right people to learn it – it was not on my radar, and my conditioning kept me where I was & then it changed when I got fed up with something!
Remember: There is real truth in the phrase ‘your network is your net worth’
This decrease in purchasing power impacts cash and savings in banks in several ways:
1. Eroding Purchasing Power
If the interest rate earned on cash in the bank is lower than the rate of inflation, the real value of those cash savings diminishes over time. For example, if your bank savings account earns 1% interest annually, but inflation is at 3%, your cash is effectively losing 2% of its value each year in terms of what it can buy.
2. Decreased Value Over Time
In an inflationary environment, the cost of items goes up. Therefore, if you have £1,000 in the bank today and inflation is at 3% for the year, the same £1,000 will have less purchasing power after a year because prices for goods and services have, on average, increased by 3%.
3. Opportunity Cost:
Cash in the bank during inflationary periods represents a missed opportunity to invest in assets that may appreciate at a rate exceeding inflation. Equities, real estate, or other investment vehicles can potentially offer returns that not only keep up with inflation but exceed it, thus growing in real terms.
4. Interest Rates and Monetary Policy:
Central banks, such as the Bank of England, may raise interest rates to combat high inflation. If the increase in interest rates on savings lags behind the rise in inflation or is lower than the inflation rate, cash savings will lose purchasing power.
5. Relative Performance to Other Assets
Inflation can impact various asset classes differently. While it may erode the value of cash, it can increase the nominal value of assets like property or commodities, making cash savings a less attractive option.
6. Fixed Income and Long-term Deposits:
For fixed-income investments or long-term deposits with a fixed interest rate, high inflation can be particularly damaging because the real interest rate (the nominal interest rate adjusted for inflation) can become negative, which means you’re effectively losing money on your investment in terms of purchasing power.
In reality, inflation devalues cash in the bank because it reduces the real spending power of that cash over time. To maintain the value of savings, it’s important to seek returns that at least match the rate of inflation.
Inflation is a crucial factor for savers and investors to consider when assessing the real return on their cash and investments.
I will share more on financial wealth and money – it is vitally important to understand and not in reality, information we are taught through the education system.
‘Nothing sits in isolation; everything is connected.’
Far more written to come on this subject & if you like audio, please hop across to The Conscious Leadership Podcast to hear more. There are over 200 episodes