Beating Inflation

Beating Inflation

At some point in your life, you have probably been advised to save your money. But many don’t know that every year that if your money is sitting in your wallet or in a bank account, it is actually losing value, and you are essentially losing money. The reason for this is called inflation.

Inflation is the rise of prices across an economy, resulting in money not being as valubale as it used to. At its core, inflation is caused when the overall quantity of goods can not keep up with demand. This can happen for several reasons. One relevant example is a major disruption to the supply of an important resource, such as oil. Since oil is necessary in many fields, the prices of other goods increase. To afford these more expensive goods, workers demand raises, and higher labor costs mean employers must further raise the prices of the goods they produce. This principle does not only apply to oil, but to any commodity where demand is higher than supply.

The average annual inflation rate in the US over the past 20 years was approximately 2.5%1. In general, inflation rates stay around 2.5% due to a combination of workers demanding raises in anticipation of more price increases, and governments producing slightly more cash than needed in the economy. There is no way to avoid inflation, but you can put your money in the stock market, which will generally allow your money to grow at a faster rate than inflation.

When you buy a stock in the stock market, you are buying a small piece of a company. The value of this “piece” fluctuates depending on a combination of the company's actual performance and how much other consumers are willing to pay for it. If a company releases a new and innovative product, people are likely willing to buy its stock for more money, which drives up the stock's value. In addition to a stock’s value going up, it can also go down if the company performs poorly or if many people decide to sell their stocks. It ultimately moves based on whether people think the stock will go up or down in the future.

The method of buying individual stocks is risky because you are essentially putting all your eggs in one basket (or a few baskets if you buy stocks of several companies). If the company does badly, you could end up losing a lot of money. A safer place to keep your money is an index fund. Placing your money in an index fund spreads your money among many different companies. One index fund is called the S&P 500, which gives you small shares of the top 500 American companies. If a few of those companies fail, there are many more successful companies to offset the losses. The S&P 500 has gained on average about 11% annually since January 20062.

By shifting from being a passive saver to an investor, you can hopefully make more money than you are losing from inflation. While the market has its ups and downs, history has shown that putting your money in the market, and staying patient, is one of the best ways to “beat inflation.”