Why inflation is burning your money like a forest fire

Psst... Want to know most people often forget about inflation?

It has a disastrous effect on your savings.

We’ve already talked about inflation in newsletters 1 and 2.

By now, you know it is in general a rise in the prices of goods and services. Everything you buy gets more expensive, as does your cost of living.

This is what we call a decrease in your purchasing power.

You can purchase less things with the same money.

But, an often overlooked side to inflation is how much it hurts your savings.

In this newsletter we’ll see how it is burning up your savings, like a wildfire. 🔥

And what we can do to remedy it.

The other side of inflation

We’ve seen rising energy prices, more expensive groceries and much more.

This all clearly hurts us in our day-to-day life.

But what about the money may have managed to save up?

You might think it’s safely stored away in your bank account, and nothing will happen to it.

This is, unfortunately, only partly true.

Let’s see you have €10.000 saved in your bank account.

On paper (or, in your app) that number doesn’t go down over time, unless you take money out, right?

However, what you can do with that money becomes less and less as prices keep rising.

In the 1920’s, you could be a new house for about $6000 dollars, or 77k$ after adjusting for inflation.

Prices rise constantly.

Money today is worth more than money in the future.

So, while the number in your bank account stays the same, the actual value of it will drop over time.

By how much, you ask?

Let’s have a look.

Example: 10k savings over 15 years

Imagine that you had managed to save up €10.000 in savings.

​Interest rate on your savings in Europe for households (that’s you and me) is still at 0%.

This means that our money literally doesn’t grow over time.

Your account balance, assuming you don’t take any money out and interest stays at 0%, will look like this:

Example: 10k savings over 15 years with 2% inflation

Now, let’s say that inflation is 2%, as it has historically been (and which is also the European Central Bank’s aim for it to be).

While the number in your bank account doesn’t change, the 2% inflation each year will keep ‘burning’ a little bit of the value of your money, in terms of purchasing power.

This is what it would look like:

Here’s the calculation if you want to check it for yourself:

10000*(1-0,02)^15

Only €7386 after 15 years! €2614 or more than a quarter of your money’s value would be lost to inflation, if you just let it sit in a bank account.

Burned away.

If you think this is bad (it is), let’s have a look at what would happen if inflation would stay at the current level of about 8%.

Example: 10k savings over 15 years with 8% inflation

Currently, inflation in the Euro area is 8.9%. Of course, the intention of the central bank is to lower this number rapidly.

Hopefully without causing a recession.

But let’s assume, for the sake of this example, that inflation stays at 8% for 15 years.

This is what your savings would look like:

So, over these 15 years, you’d end up with only €2.863!

You’d effectively lose more than 71% of your money in terms of purchasing power.

You might think your money is safely sitting in your savings account (and it is, technically speaking), but the amount of things you can buy with that money will go down drastically over time.

Here’s the calculation, if you want to check it for yourself:

10000*(1-0,08)^15

A bit of nuance

Of course, inflation won’t be 8% over 15 years (at least I sure hope so!)

In this chart, stemming from the first newsletter, we can see how inflation has fluctuated over the years.

There have been periods where inflation has been (close to) 0%.

As stated before, the official goal of the European Central Bank (ECB) is 2%, so this is a good average to use for our estimates.

What can we do about our money losing value?

Investing!

Investing is a way of hopefully creating more money with our current money.

If we can earn a higher return % than the level of inflation, we can stop losing money.

Or, even better, even make the real value grow.

Investing of course has risk involved, so this is not something that we should do with all of our money.

Our emergency fund should stay in our bank account, because we need to be able to access it whenever we need it.

We should only invest with money we won’t need for the next 10-15 years. More on that later.

But investing can be a great way to beat inflation effectively.

In fact, it may be the only way out.

Conclusion

Inflation is slowly burning the value of our money away.

The higher the inflation, the faster our money loses its value.

Investing can be a great way to fight inflation, by “earning” faster than inflation can burn away our money.

But it involves some risks too, so we should be smart about how go about investing.

More on investing soon!

What did you think of this newsletter? Please use the links below and let me know! If you liked it, please forward it to your friends and colleagues, and ask them to sign up!