Inflation and your savings

Resources · Home loans and saving · 5 min read Building

Key points

• Inflation means prices rise over time, so the same money buys less.
• Your savings only grow in real terms if they earn more than inflation, after any tax.
• Inflation compounds. Small yearly rises add up over a decade or more.
• It touches debt too: a fixed balance gets easier to carry as incomes and prices rise.

Inflation and savings: what inflation is

The link between inflation and savings is simple once you see it. Inflation is the general rise in prices across an economy. When it’s running at 3% a year, a basket of shopping that cost $100 last year costs about $103 now.

Many countries measure it with a consumer price index, which tracks the cost of a typical set of goods and services. Your own experience can be different. What you spend money on may not look anything like the average.

Here’s the part people miss. Inflation doesn’t make your money disappear. The number in your account stays put. What changes is how much that number can buy.

A worked example: cash that earns nothing

Assumptions:

• $10,000 held as cash, earning no interest
• Prices rise by 3% every year, compounding

The same maths works in any currency.

After 10 years, the $10,000 still says $10,000. But it only buys what $7,440.94 buys today. Give it 20 years and it has lost nearly 45% of its buying power.

That’s because inflation compounds, just like interest does. Each year’s rise sits on top of the last one.

Interest versus inflation

So what actually matters for your savings? The gap between the interest you earn and inflation. People call this the “real” return.

Assumptions:

• $10,000 starting balance
• Interest paid monthly at one-twelfth of the yearly rate, no tax or fees
• Prices rise 3% a year
• 10 years

At 1%, the balance grows. But prices grow faster, so in real terms you’re going backwards. At 4%, your savings outpace prices and your buying power goes up.

Want a quick estimate of the real rate? Take the interest rate and subtract inflation. In the 4% example, that’s about 1% a year.

Tax changes the picture

In many countries, interest on savings is taxed. And the tax applies to the interest itself, not just the slice above inflation (some countries have tax-free allowances or accounts). So a rate that looks like it beats inflation might not, once tax comes off. How this plays out depends on where you live and what you earn.

What inflation and savings mean for each goal

Inflation hits money differently depending on the job you’ve given it.

Emergency funds need to be safe and easy to reach, so most people keep them in cash accounts (see where to keep an emergency fund). Keeping pace with inflation is a bonus here, not the point. Still, your essential costs rise with prices, so it makes sense to look at the target every year or two.

Saving for something a year or two away? Inflation can nudge the price up while you wait. A small buffer in your target takes care of that.

Long-term savings are where inflation does the most damage, because it has decades to work. That’s one reason people saving for retirement often hold some investments that may grow faster than prices. The trade-off is that their value can go up and down along the way.

Inflation and debt

On a debt with a fixed balance, inflation works in the other direction. Owe $10,000 while prices and wages rise, and that $10,000 becomes a smaller share of your income over time.

Sounds handy. But there are catches. Central banks may raise interest rates when inflation is high, and that can push up variable loan and credit card rates. Rising prices squeeze your budget, which can leave less room for repayments. And high-interest debt usually costs far more each year than inflation takes off it.

So inflation might ease the weight of a fixed debt a little. It won’t pay it off for you. If rising costs have made your repayments hard to meet, free debt help is available and confidential.

Keeping perspective

You can’t control inflation. Nobody can, from their kitchen table. What you can do is check where your savings sit, whether they earn a rate that keeps up, and whether your targets still match today’s prices. Small adjustments, made regularly, help your money hold its value.

Common questions

How does inflation affect savings?

Prices rise, so the same money buys less. Your savings only grow in real terms if they earn more than inflation, after any tax.

What is a real return on savings?

It’s the gap between the interest you earn and inflation. For a rough figure, take the interest rate and subtract the inflation rate.

Does inflation make debt easier to pay?

It can shrink a fixed balance as a share of your income over time. But high-interest debt usually costs far more each year than inflation takes off it, and rising prices can squeeze your budget.

Try it

The compound interest calculator shows how your savings could grow at different rates, so you can set them against the inflation rate you expect. To see your whole debt picture, find your Freedom Date.

General information only, not financial advice. Your situation is your own.