Inflation is consistently a hot topic of discussion among financial experts and economists, and it has a bearing on many things. For instance, a country’s economy, the price of your daily commodities, services, and so on. It also affects your savings and investments. Here are some basic things about inflation that you may want to bear in mind.
Inflation is a situation where the value of your money decreases and the average price of things increases. Consequently, you will now need to fork out more money to buy an item, when you could pay less previously. So for example, you’re planning to buy a motorcycle for $1000. However, assuming the inflation rate is 3%, you’ll then have to pay $1030 for your motorcycle instead.
Inflation happens for three key reasons. Firstly, the increase of demand for a certain product or service may cause sellers to increase the price of the in-demand item, thereby causing inflation. Inflation also happens when companies hike the prices of products when production costs increase. Lastly, the oversupply of money in the market may decrease its value, which forces sellers to up the prices of their products, ultimately resulting in inflation.
That said, how does inflation impact your savings? Here’s a scenario to illustrate: let’s say you placed $100 in a savings account that pays 1% in interest in 2019. This means that in 2020, you will have $101 in your account, which you can then (theoretically) use to buy a pair of shoes that cost $100 in 2019. In fact, you will even have an extra $1 left! However, if the inflation rate for the year is 2%, then the shoes will now cost $102, and you will have to top up another $1 to buy your item. In other words, inflation has shrunk your buying power despite earning an extra $1 from the interest rate of your savings account, thus giving you no real return.
Another popular method is to park your money in fixed deposits which provide a fixed interest rate with lower risk. Fixed deposits offer higher interest rates than regular savings accounts, which allows you counteract the effects of inflation. You will, however, have to bear with the drawbacks of not having immediate access to the money in your fixed deposits or funds, or needing to pay a penalty for premature withdrawals.
Consider investing in property to protect yourself from inflation as real estate typically appreciates in value. You could also benefit from getting a fixed-rate home loan, which essentially means that you lock the interest rate charged to your loan. Once locked, the interest rate of your loan will remain the same during the specified time period, regardless of the fluctuating market interest rate. Doing so will negate the effect of inflation, although it also means that you will not benefit from a lower interest rate either if the market rate drops.
Lastly, there are several alternative investment avenues that can help you protect yourself from inflation. One approach is to consider investments whose value rises with inflation, particularly if it provides regular income in the form of dividends or interest. This could include inflation-linked bonds, real estate funds or dividend-paying stocks. And example of such assets could be stocks in commodity resource companies which are less affected by inflation – such as those selling oil, grains, and metal – because they are not subjected to the price adjustments by manufacturers and distributers.
Ultimately, you will realise that inflation is an unavoidable phenomenon, but it is possible to plan for it with thoughtful and careful management of your finances.
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