Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Think of it this way: if last year a loaf of bread cost $2 and this year it cost $2.20, that price increase is a part of inflation.

So, why does inflation happen? It can be due to various factors. One common cause is when the demand for goods and services in an economy outstrips the supply. This can happen during periods of strong economic growth. Another reason could be the rising costs of production — for example, if the price of oil increases, it costs more to transport goods, leading to higher prices.

Inflation isn’t always bad. A moderate level of inflation is a sign of a healthy, growing economy. Problems arise, however, when inflation rates are either too high or too unpredictable. High or erratic inflation rates can lead to economic uncertainty as people and businesses find it harder to plan for the future.

Inflation and Purchasing Power

Purchasing power is the amount of goods or services that one unit of money can buy. When inflation rises, the value of the currency falls, meaning your money doesn’t stretch as far as it used to.

Imagine you have $100. Last year, this might have been enough to buy a week’s worth of groceries. But with a 5% inflation rate, those same groceries would now cost $105. You’re essentially getting less for the same amount of money. This is what we mean when we say that inflation erodes your purchasing power.

Inflation Impact on Savings

When inflation outpaces the interest rate on your savings, you’re essentially losing money in terms of purchasing power. This might be hard to notice year to year, but over time, it can diminish the value of your savings.

This doesn’t mean you should stop saving money. Instead, it highlights the importance of considering inflation when choosing where to put your savings. 

Inflation and Debt

Understanding the relationship between inflation and debt can influence your financial strategy. In times of high inflation, it might be more beneficial to focus on paying off debts with adjustable interest rates, which can increase with inflation, while maintaining fixed-rate debts. 

Wages and Inflation

The relationship between wages and inflation is a crucial aspect of personal finance. Ideally, wages should increase at a rate that matches or exceeds inflation to maintain purchasing power. However, this isn’t always the case.

When inflation rises, the cost of living goes up, making it more expensive to buy goods and services. If wages don’t increase at the same pace, people find that their income buys less than it used to. This scenario can lead to a decrease in real income, where you may earn the same amount of money, but it has less purchasing power.

Coping with Wage and Inflation Dynamics

• Negotiating Wages: It’s important to consider the inflation rate when negotiating salaries or raises. Aim for wage increases that at least match the current rate of inflation.
• Budgeting and Spending: Adjust your budget to accommodate the increased cost of living. This may mean prioritizing essential expenses or finding ways to reduce costs.
• Side Income: Consider diversifying your income sources. A side job or passive income stream can provide additional financial cushioning.
• Skill Development: Continuously improving and updating your skills can make you more valuable in the workplace, potentially leading to higher wages.

Impact on Retirement Savings and Pension

Over time, inflation can decrease the value of your retirement savings. For example, with an annual inflation rate of 3%, what costs $10,000 today would cost about $18,061 in 20 years. This means your retirement savings need to grow not only to support you longer due to increased life expectancy but also to outpace inflation.

For those with a fixed pension, the impact can be more direct. If your pension doesn’t include cost-of-living adjustments that account for inflation, you might find your income buying less and less each year.

Adjusting Retirement Plans for Inflation

• Consider Inflation in Your Savings Goal: When calculating how much you need to save for retirement, factor in inflation. Use an inflation-adjusted figure to set a more realistic savings goal.
• Invest Wisely: Include assets in your investment portfolio that have the potential to outpace inflation, such as stocks or real estate.
• Regular Review and Adjustment: Regularly review and adjust your retirement plan. As you approach retirement, your strategy might shift from growth to preserving the purchasing power of your savings.

Tips for Managing Expenses and Maintaining Purchasing Power

• Track Price Changes: Keep an eye on the prices of items you regularly purchase. This awareness can help you adjust your spending habits or switch to more affordable options.
• Focus on Essentials: Prioritize spending on essential needs. This might mean cutting back on luxury items or non-essential services.
• Seek Discounts and Deals: Look for discounts, use coupons, and consider bulk buying for non-perishable items to save money.
• Reduce Energy Costs: Implement energy-saving measures at home to lower utility bills.
• Increase Income if Possible: Consider ways to boost your income, like taking on freelance work, asking for a raise, or pursuing a higher-paying job.

Conclusion

When the purchasing power diminishes, it can put a strain on your finances. This means that if you’re juggling multiple debts with this, you can become stressed out and overwhelmed. You need help to go through that phase so you don’t get weary. Our debt experts at EmpireOne Credit are here to listen to you and proffer solutions to help you manage your debt better without losing your sleep. Your debt can be reduced by up to 80%, and interest will stop immediately. Call us at (416) 900-2324, to schedule a free consultation with us. Being debt-free feels good!