The average American’s financial struggles are well-documented. In 2019, CBS reported that 20% of workers spend more than they earn. Overall, seven in ten people have trouble managing at least one aspect of financial stability. Keep in mind that all of these trends emerged during a strong economic period, before the pandemic of 2020.
While some people don’t have sound financial practices, many of us actually make an effort. We scout the best mortgage rates when buying homes, try to pay bills on time, and settle debt before the interest grows. Whenever possible, we set aside excess money in an emergency fund or savings account.
The problem with abiding by certain financial rules of thumb is that you potentially miss out on the big picture. By saving money without hard guidelines and clearly defined goals, you can’t see the forest for the trees. Our real goal in the long term must be outpacing inflation.
The phenomenon of inflation
What is inflation, and why does it happen?
Everyone has parents, grandparents, or other people they know from older generations who’ll shake their heads at today’s prices and say, “In my day, this wasn’t so expensive.” They can’t believe how low the value of the dollar has fallen. That’s the effect of inflation over the decades.
Many factors cause inflation. The rising costs of production over the years tend to be passed on to consumers. This includes wages. Thus, even if you receive a pay raise, your purchasing power likely remains the same if that came about as part of a larger overall wage increase.
Fiscal policy can also intervene to affect inflation. So why doesn’t the federal government step in and make things easier for consumers? The conflict here is that inflation is actually good for the economy. It encourages investment, production, and spending. The opposite phenomenon of deflation brings countries dangerously close to economic collapse.
Thus, the general trend over the years is always one of a slow and steady increase in prices. The average yearly rate of inflation in the US is 1.7%. If you are only setting aside money in a savings account with annual interest rates lower than that, the value of your savings is actually decreasing with each year.
Make no mistake; being able to set aside some money is a good thing. Savings accounts are a valuable tool for personal finances. They keep money secure yet accessible in case of need. Overall, maintaining your savings is a testament to how much you’ve already managed to accomplish in terms of financial stability.
Equally, however, you need to realize that securing your long-term financial future is an entirely different sort of challenge. The methods you’ve used to achieve current success may not be enough to go the distance.
Your real goal must be outpacing inflation. And you have a concrete number in that regard. Aim to grow your money by more than 1.7%, preferably far more in case of sudden volatility.
Not everyone is fortunate enough to work in a job that guarantees an annual increase in wages to beat inflation. This means you have to be even more stringent in curtailing expenditure, or supplement your income with a side hustle, or do both.
Another option that can stand on its own or be used in combination with those measures is investing your money in products with high long-term potential returns. Some options that may be easily accessible to the new investor include stocks, bonds, retirement funds, and high-interest savings accounts.
Although there are no guarantees, these options certainly can earn more than the rate of inflation. The S&P 500, for example, averages annual returns of around 10%.
The downside of that potential is the risk. The value of a given stock may depreciate unpredictably. Not only does that reduce the effective value of your money, but it also compromises your liquidity. Pulling out of the market at the wrong time means losing money, but you can’t always foresee circumstances that would call for emergency funds.
An understanding of the risks must accompany any foray into investment. Not only the inherent volatility but the implications for your personal lifestyle and goals.
Every investor is well-advised to diversify their portfolio. This limits your exposure to unforeseen negative events. Make it your goal to have a mix of financial products. It’s a complicated frontier that will require you to step up in terms of financial literacy. But when the alternative is certainly locking yourself into the depreciation associated with inflation, it’s worth the effort.