You must have observed that time is passing, and the cost of living is consistently increasing. There has been a lot of news about rising prices. The question is, what is the inflation rate and how does it affect your savings account? Read on to understand the concept and find effective ways to reduce its adverse effects on your financial goals.
What is Inflation?
Inflation means the rate at which the prices of products in an economy increase over time. Putting it simply, when inflation takes place, the money you owe buys a smaller portion of goods and services that you purchased the previous year. Inflation indicates a decrease in the purchasing power of a currency as the cost of living increases.
How Inflation Affects Your Savings Account
Inflation influences the purchasing power of your savings account. With the increase in the overall prices of goods and services in the economy, the value of money decreases, leading to a decrease in the purchasing power of your savings. Here is how market inflation impacts your savings.
1. Reduce the Value of Your Savings
Inflation can reduce the actual value of your savings. If the inflation rate is more than the interest rate on your savings account, the purchasing power of your savings will reduce over time.
2. Savings Goals
If you have set specific goals, such as retirement or education, inflation can make it challenging to attain these goals. Your money may not increase as quickly as you expect, making it essential to invest wisely to deal with the rising costs.
3. Erosion of Returns
The conventional savings account interest rates are usually lower than the inflation rate. This means the interest earned on your savings account is insufficient to combat rising prices.
How to Combat the Impact of Inflation on Your Savings Account?
To mitigate the eroding effects of inflation on your savings account, you may consider the following strategies:
1. Diversify your Portfolio
Consider spreading out your investment portfolio by investing in assets that overcome inflation, such as real estate, stocks and mutual funds. With diversification, you can spread the risk and earn higher returns over time.
Depending on your financial goals, allocate some of your savings to different asset classes.
2. High-Return Investments
Look for investment options that can generate higher returns than the inflation rate. However, investments that hardly beat inflation may not be appropriate for those seeking wealth. Below are the investment options that can help you beat inflation:
● Real Estate: It is an illiquid investment appropriate for long-term investors. It has been a perspective category for the last few decades. However, several factors should be considered when investing in real estate, including location, infrastructure, transportation, and government policies, as these can impact property value.
● Equity: Investing in stocks can maximise wealth and beat inflation, which is particularly appropriate for young investors. Invest in Equity-linked savings schemes (ELSS) that offer tax benefits. Another option is Unit-linked insurance plans (ULIPs) that provide tax benefits on investments and are free from tax on maturity.
● Gold: Gold is a powerful weapon against inflation, as its value generally increases along with the inflation rate. However, the opportunity cost of holding gold increases when inflation and interest rates increase.
3. Budget and Save
Keep track of your budget and continue saving regularly. If you consistently contribute to your savings and consider higher-yield investments, you can overcome the impact of inflation.
Moreover, monitor the interest rate on your savings account closely and match it with the current inflation rate. Switch to savings accounts or investment options that offer higher returns whenever necessary.
4. Consulting a Financial Advisor
Seek expert advice from a finance professional who can provide personalised assistance depending on your financial situation and help create a strategy to deal with inflation and maintain the value of your savings over time.
Final Words
Savings accounts can be negatively impacted by inflation. Still, there are alternative ways to deal with it, such as spreading your money over other assets like mutual funds and stocks. This can help you achieve better growth and maintain your purchasing power, ensuring a more secure financial future.