There's really little that can be done to predict the inflation rate going into the future but the long-term sustainable rate has historically been around 3%. So if you keep $100 under the mattress, that same $100 will have around $97 of purchasing power in a year if inflation is 3% after prices have gone up. Now 3% might not be a big deal but remember, inflation rates compound over time. Here's a table of how much money you'd need to buy the same goods costing $100 today if inflation stays at a constant 3% and how much that same $100 will buy in the future (in today's dollars):
Year
|
Inflation Adjusted Amount
of Today's $100
|
Purchasing Power of $100
Today
|
0
|
100.00
|
100.00
|
1
|
103.00
|
97.09
|
2
|
106.09
|
94.26
|
3
|
109.27
|
91.51
|
4
|
112.55
|
88.85
|
5
|
115.93
|
86.26
|
6
|
119.41
|
83.75
|
7
|
122.99
|
81.31
|
8
|
126.68
|
78.94
|
9
|
130.48
|
76.64
|
10
|
134.39
|
74.41
|
11
|
138.42
|
72.24
|
12
|
142.58
|
70.14
|
13
|
146.85
|
68.10
|
14
|
151.26
|
66.11
|
15
|
155.80
|
64.19
|
16
|
160.47
|
62.32
|
17
|
165.28
|
60.50
|
18
|
170.24
|
58.74
|
19
|
175.35
|
57.03
|
20
|
180.61
|
55.37
|
21
|
186.03
|
53.75
|
22
|
191.61
|
52.19
|
23
|
197.36
|
50.67
|
24
|
203.28
|
49.19
|
25
|
209.38
|
47.76
|
26
|
215.66
|
46.37
|
27
|
222.13
|
45.02
|
28
|
228.79
|
43.71
|
29
|
235.66
|
42.43
|
30
|
242.73
|
41.20
|
31
|
250.01
|
40.00
|
32
|
257.51
|
38.83
|
33
|
265.23
|
37.70
|
34
|
273.19
|
36.60
|
35
|
281.39
|
35.54
|
36
|
289.83
|
34.50
|
37
|
298.52
|
33.50
|
38
|
307.48
|
32.52
|
39
|
316.70
|
31.58
|
40
|
326.20
|
30.66
|
In other words, your $100 will be worth about $30.66 in today's dollars 40 years from now and you'll need about $326.20 to buy the same goods $100 will buy today.
But if I keep money in a Savings Account, I can earn interest which will offset inflation, right?
Sometimes, yes. In recent times (since around 2000), most likely, no. According to inflationdata.com, the average inflation rate from 2000 to 2009 was about 2.56%. Since you need to pay taxes on interest on a savings account, you'll need a much higher interest rate to keep up with inflation. If your tax rate is 30%, you'll need a 3.7% interest rate, and if your tax rate is 40%, you need 4.3%. Unfortunately, rates have been at 0.25% since 2008 and have only exceeded 4% for only a minority of periods since 2000. Although some investors don't include Savings Accounts as a legitimate investment vehicle, there are times when it may be prudent to earn interest in a savings account (for example, in the early 1980s when interest rates were vastly higher than inflation.) But there exists no mandate that the interest paid on savings accounts must keep up with inflation and they have underperformed inflation for long periods in the past, so I don't think it's wise to rely on them for inflation protection.
Why don't I use TIPS instead? They're designed to keep up with inflation!
TIPS, a government bond that pays you interest based on the inflation rate, sounds like the holy grail to our inflation problem, right? One problem though: you have to pay taxes on the interest from these bonds. After paying taxes, you will NEVER beat inflation. Back to the drawing board.. almost.
Putting TIPS in a tax-exempt or even a tax-deferred account may relieve you of the above problem and actually allow your money to grow at the inflation rate. These accounts are known as Roth and Traditional IRAs, respectively. Unfortunately, you cannot withdraw money from these accounts until you are age 59.5 or older. If you will be 59.5 soon, they may not be a bad idea for inflation protection, but if it's decades away for you, you might as well turn to investing with that long of a time frame.
Want to learn how to get started investing? Please stay tuned!
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