If you watch the news, you have most certainly heard the term inflation thrown around every so often. While you understand the basic concept of inflation, the rise of prices over time, you may still be left wondering how inflation impacts your wallet.
So today, I am going to show you just this. The goal is to help you see exactly how inflation, whether it is rising or falling, impacts your finances on an everyday basis.
By understanding this, you can make better financial decisions to get ahead.
5 Common Ways Inflation Impacts Your Wallet
#1. Increased Cost Of Goods
Since the basic definition of inflation is the rising of prices over time, the increased cost of goods should not come as a surprise. As inflation grows, the cost of everything you buy increases too. But you have to understand that even if inflation holds steady, prices are still increasing.
Over the long term, inflation has averaged 3% annually. This means that for every dollar something costs, the next year the price will be $0.03 more. And then another 3% the following year, and so on.
For example, let’s say the price of a gallon of milk is $4 today. Assuming inflation is 3%, next year the price of milk will be $4.12. The year after that, milk will be 3% higher again.
This is true of all goods you buy. As inflation increases, the prices you pay will increase. This is another reason why having one dollar today is more valuable than having one dollar tomorrow.
#2. Increased Savings Account Rates
While it’s painful to read that the cost of everything goes up thanks to inflation, you can also benefit from its rise as well. This is done through the interest you earn on your savings accounts.
As inflation rises, the Federal Reserve works to control it by raising or lowering interest rates. By changing interest rates, the Fed is able to keep inflation in check. We can be certain it won’t rise too quickly or drop too fast.
Both of these are bad, but I won’t get into why this is the case for now. Let’s just focus on interest rates. When the Fed raises interest rates, you will begin to earn more money on your savings at the bank.
The key point here to remember is that whatever rate inflation is rising at, you need to be earning this much to simply keep even. What does this mean?
If inflation is rising at 3% and you are earning 2% on your savings, you are losing purchasing power. The cost of an item rose $0.03 per dollar but your one dollar in savings only grew $0.02.
This is why so many people choose to invest in the stock market. They can more easily stay ahead of inflation and keep their purchasing power.
#3. Increased Borrowing Costs
Another way inflation impacts your wallet is through borrowing costs. As I pointed out above, the Federal Reserve changes interest rates depending on how quickly inflation is rising or falling. In the case of inflation rising too quickly, the Fed will begin to raise interest rates.
Not only will your savings account rate increase, but so will the interest rates you are charged to borrow money. This covers everything from credit cards to home loans and everything in between.
After all, if it is costing banks more to borrow money, then they are going to pass these costs along to the borrower in the form of higher interest rates.
This is why right now there has been such a strong push for home refinancing. With interest rates hovering new all time lows for so long, it makes sense to refinance and lock in the interest rate for 30 years.
And as interest rates rise, you want to lock up your money as you don’t want to be paying more interest in the coming years.
Of course the reverse is true as well. If inflation is low and interest rates begin to fall, you don’t want to lock in your rate as you can save money with falling rates.
#4. Cheaper To Travel Overseas
When inflation creeps higher in the Unites States, it makes traveling overseas less expensive. How does this work? With a stronger dollar, paying for things in US currency will be cheaper since the currency will be in demand overseas.
Of course, while is this good for US travelers going abroad, it is not good for tourism here in the US. Since foreign money will be less desirable here, it will cost foreign travelers more money to visit the US.
#5. Higher Wages
Finally we come to wages. Inflation has an impact here as well. As inflation rises and things cost more money to purchase, workers will demand a higher income. New hires will be offered larger starting salaries and existing workers will need to be paid raises to keep them from quitting and finding work elsewhere.
In fact, even if inflation is low, a tight job market can lead to inflation. This is because with fewer candidates for open jobs, employers will begin to offer higher salaries to lure people in. As people earn more, they will drive up demand for goods and services and thus inflation rises.
As you can see, inflation impacts your wallet in many ways. From the cost of buying goods, to saving and borrowing money, and even traveling the world, inflation has an impact on everyone’s financial life.
The sooner you understand this and the ways to make sure inflation has the least impact on you, the sooner you can get ahead financially.
You don’t have to sit back and watch inflation destroy your wealth. Take the steps to be proactive and inflation won’t cause you stress.