The Impact of Inflation on Your Savings Account and How to Combat It

Inflation is likely the most subtle but sustained threat to your savings. While your savings account might seem like a safe place to park your money, inflation can erode its true value over time. Understanding how inflation works on your money and learning how to counteract its effects can help protect your financial future.

What is inflation?
Inflation is the general increase in the price of goods and services over some time. As prices rise, the purchasing power of your money decreases. That is, the same money is used to purchase fewer goods than it did last year. A 5% inflation rate does not seem like a lot, but it can really make a difference in your savings over a long period.

How inflation impacts your savings account
Most savings accounts pay relatively low interest rates, usually in the range of 2% to 4% annually. If your account interest rate is lower than the inflation rate, then the purchasing power of your savings effectively erodes. Suppose your account yields a 3% interest per annum and inflation is 6%. Your money has effectively lost 3% of its purchasing power in real terms.

This gap may not feel inherently significant, yet in the long run, it can lead to a decrease in what your savings are really purchasing. In essence, you may be losing cash while you are saving it.

Why rethink traditional savings accounts?
Their ideal function is liquidity and short-term needs. However, they are not set up to save or build wealth if inflation hit. That is where digital savings accounts may gain ground. Due to their low-cost-to-operate business model, digital banks also offer a greater return in the form of higher interest, and a few come paired with open investment vehicles connected to the account directly.

By checking out online alternatives, not only do you enjoy competitive rates, but you are also getting features that help you manage your money better—such as automated budgeting, smart saving aids, and live tracking.

How to fight inflation
You cannot defeat inflation, but you can act positively to prevent its effects on your savings:

1. Compare and change accounts
Not all savings accounts are the same. Compare interest rates regularly and switch to digital savings accounts with better returns. Even a 1% difference will make a significant impact eventually.

2. Diversify your savings
Have a portion of your savings in higher-yielding financial assets. Consider fixed deposits, mutual funds, or inflation-indexed bonds. They can earn better returns and compensate for inflation.

3. Automate and review regularly
Use automation to transfer funds from your savings account into higher-return investments on a regular basis. Review your plan every few months to ensure it keeps pace with inflation rates and your objectives.

4. Save for a purpose
Longer-term goals are affected more by inflation than short-term needs. Decide what you are saving for—emergency savings, vacations, education—and choose accounts or tools best suited for each objective.

Final thoughts
Inflation may be inevitable, but its impact on your savings does not have to be. Having an understanding of how it eats away at value and taking deliberate steps—such as shifting to electronic savings accounts, diversifying your investments, and reviewing your money plan—you are able to keep your money increasing despite inflation.