From financial boardrooms to living rooms, the damaging effects of inflation have become the focus of conversations in New Mexico and across the country. In today’s economy, understanding how to protect savings from inflation is increasingly important for your finances. This article offers five practical tips to help you safeguard your financial future from the impact of inflation.
What is Inflation?
Inflation measures the rate at which the general level of prices for goods and services rises. This overall increase in prices erodes the purchasing power of money and acts like an invisible tax that nibbles away at the value of money over time.
In recent years, the COVID-19 pandemic has had a profound impact on the global economy, leading to unique inflationary pressures. Some key causes of the recent bouts of inflation include:
- Supply Chain Disruptions: The pandemic led to interruptions in global supply chains that resulted in a scarcity of goods, driving up prices.
- Increased Government Spending: To fight the economic fallout of the pandemic, governments around the world have engaged in significant fiscal stimulus, effectively pumping money into the economy.
- Pent-Up Demand: As restrictions lifted, eager consumers spend money which leads to demand outstripping supply, adding to an upward pressure on prices.
- Labor Shortages: Health concerns and changing work conditions have caused labor shortages in various sectors of the economy, driving up wages for existing workers who demand higher compensation.
- Rising Commodity Prices: The pandemic has affected the price of commodities, including essential raw materials like oil and metals. This has had a domino effect that pushes up the costs of goods that rely on these materials.
The 2022 inflation rate in the US peaked at 6.5 percent, far above the ideal inflation rate of 2 percent per year. Year-over-year inflation from 2022 to 2023 is estimated to be 2.7 percent, according to the U.S. Bureau of Labor Statistics.
Impacts of Inflation
The negative consequences of inflation touch nearly everyone, eroding economic stability and complicating long-term financial planning:
Reduced Purchasing Power
- One of the most direct and widespread effects of inflation is the decline in the purchasing power of money. When inflation rates rise, each unit of currency buys fewer goods and services.
- The greater the rate of inflation, the more significant the decrease in consumers’ purchasing power.
- Those saving for a goal like a down payment on a house or education costs lose purchasing power over time.
Fixed Income & Lower Income Challenges
- Retirees and others on fixed incomes may find it more difficult to maintain the same standard of living as inflation erodes their purchasing power over time.
- Lower income consumers typically spend a larger percentage of their income on needs when compared to those with higher incomes, leaving them less protected from the loss of purchasing power brought on by inflation.
- Lower income households are less likely to own real estate, a significant asset that serves as a defense against inflation.
- Lower-income earners spend a significant amount of their budget on food and energy, commodities whose prices are not included in core inflation measurements, which can result in masking the full negative impact of inflation.
Increased Cost of Borrowing & Investment Risks
- A common response of central banks and policymakers to inflation is to increase the minimum interest rate, limiting the money supply and increasing the cost of borrowing.
- Inflation affects real returns on investments. If investment returns fall below the rate of inflation, investors lose money in real terms and may turn to safer alternatives such as Treasury bonds that generate a lower return.
Struggling with debt? Read the DNCU Complete Guide to Consolidating and Paying Off Debt and reach out to DNCU today for useful guidance on becoming debt-free.
How to Protect Your Savings During Inflation
Despite the dire headlines and analysis, inflation is not an insurmountable obstacle. Using the right strategies, it is possible to safeguard your savings and even turn the situation to your advantage. Consider the following tips to navigate your way around the worst effects of inflation:
Find the Best Savings Accounts Rates
- Use a comparison tool to find the most competitive savings accounts from credit unions or other financial institutions.
- Read the fine print and look for fees, monthly minimum account balance requirements, and other details.
Open a Certificate of Deposit (CD) Account
- A Certificate of Deposit (CD), often referred to as a Share Certificate by credit unions and other not-for-profit financial institutions, offers a fixed interest rate that may outperform a regular savings account during periods of high inflation.
- A CD applies penalties for early withdrawals so consider the recommended term of six to twelve months to take advantage of a higher interest rate without locking up money for too long.
Invest in Real Assets
- Real estate and commodities, such as gold, often perform well during inflationary periods. Consider investing in these types of real assets and use them as a hedge against inflation.
- The intrinsic value of these assets tends to rise along with inflation and retain their worth even as the purchasing power of money declines.
Develop Retirement Accounts
Contributing to retirement savings accounts provides tax advantages that help your savings grow more efficiently. These types of accounts often allow for a wide range of investment options, including stocks and bonds, which can adjust to effectively fight the worse effects of inflation:
- 401(K): Experts recommend 10% of a person’s salary go to a 401(K) with enough savings to support 60% to 80% of pre-retirement income.
- Individual Retirement Account (IRA):
- A Traditional IRA is the preferred choice for those without access to a traditional 401(K) through their workplace or for those who have reached the maximum contribution but would like to extend retirement savings for that tax year.
- A Roth IRA remains the preferred choice for younger individuals and others who expect to be in a higher tax bracket in the future, people with diverse income sources in retirement, those who value flexibility and wish to withdraw contributions without penalties, and long-term investors who can reap the growing benefits of tax-free growth over a longer timeline.
DNCU offers two options for those interested in taking advantage of Individual Retirement Accounts as part of a successful retirement strategy. Get more information and check the latest IRA Certificate rates.
Keep an Emergency Fund
Maintaining an emergency fund is a critical component of financial planning, especially in times of inflation. An emergency fund is a separate savings account that is easily accessible and is reserved for basic needs and unforeseen expenses such as medical emergencies, vehicle repairs, or unemployment.
- During inflationary periods, the costs of unexpected expenses can rise, making an emergency fund even more important.
- A general guideline is to maintain three to six months’ worth of living expenses saved in an emergency fund. This financial cushion will help you avoid having to dip into long-term investments or use credit cards or rely on other high interest debt to cover immediate needs.
Del Norte Credit Union is your ideal partner for a better future!
While the challenge seems daunting, it is possible to protect your savings and your financial future from the corrosive effects of inflation. One action you can take today is to open a DNCU Share Certificate. Ranking among the best CD savings rates in New Mexico, a DNCU Share Certificate is a secure and effective way to maximize your savings in uncertain times.