How can I protect my money from inflation?

For months, inflation has grabbed many headlines in the media. But the truth is that it is always a recurring theme when we talk about economics. And it is normal for it to be so, because it has a very direct impact on our daily lives.

Not everyone is interested in the economy, but we should all be concerned about inflation, since it always affects us. For this reason, in this article we will try to answer a question that millions of people ask: how can I protect my money from inflation?

How does inflation affect us?

It is as if the fruit of our effort, year after year, were disappearing

The first thing we must clarify is that, when we talk about inflation, we are not referring to any price increase that we see in a product. As in any market where there is supply and demand, the price of a product can go up or down. This, depending on the behavior of businessmen and consumers. But inflation is not that, but a more complex monetary phenomenon.

Actually, inflation is the trend that an economy presents when, in general, all prices rise. It is, to put it in some way, a kind of upward inertia that seems to infect all economic sectors.

To understand the problem that this poses for our savings, let’s see a simple example.

Let’s imagine that we want to buy a car that costs $12,000, and to do so we decide to save $500 a month for 2 years. Under these conditions, after a year we will already have saved 6,000, that is, 50% of the car.

Suppose that in the first year there was 10% inflation, and the price of the car has risen to 13,200. We still have our 6,000 saved in the bank, but now it is no longer equal to 50% of the car, but 45%. So to speak, our money has just been devalued relative to the car.

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Now, maintaining a monthly savings of 500, to cover the remaining 65%, it will no longer be enough to save 12 more months as we had initially planned, but 15. Another option would be to save more every month, perhaps by cutting costs on other things or working more to increase our income. In any case, we will have to make a greater effort.

If we also count the long-term effects, the picture is even worse. In Argentina, for a movie ticket that in 2001 was obtained for 5 pesos, in 2021 more than 800 were paid. In other words, an Argentine who had 800 pesos in the bank in 2001 knew that his savings allowed him to go 160 times to the movies. Twenty years later, that same money was only worth one ticket.

That means that when there is inflation, the value of our savings further back in time is diluted. It is as if the fruit of our effort, year after year, was disappearing.

The good news is that there are ways to protect our money from inflation, so that over the years the rise in prices is as little noticeable as possible. Let’s see some of them!

Investment for beginners: a fixed-term deposit

If we want not to think too much and let our money work for us, a fixed-term deposit is the best option

One of the simplest options is to leave our money in a fixed-term deposit. In this way, we should not think too much and we have the peace of mind that, in many countries in the world at least, the deposit is guaranteed by the Central Bank. We can say that, in general, it is a good alternative for our savings to generate interest every year and thus we can increase our capital.

However, there are two aspects that we have to consider. The first may be very obvious, but we cannot ignore it for that reason: reinvest interest. That means that if we make a deposit of 1,000 dollars at 10% interest, the first year the bank will pay us 100, but if we leave that money in the account, in the second year we will already have 1,100 accumulated and the bank will have to pay us 110 , and so on.

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On the contrary, if we take the interest out of the account and spend it, our capital will not be able to grow. We will continue to have the same amount in the deposit each year, but with inflation that money will be worth less and less. For this reason, it is essential that we understand the importance of capitalizing on inflation, that is, of ensuring that our savings continue to grow.

The second aspect to take into account is to make sure that the interest rate they offer us is higher than the expected inflation for this year. In some countries, banks offer deposits with interest that varies according to inflation. If we do not have that possibility, we can look for forecasts for consumer price indices in our country and compare them with the bank’s interest rate.

The reason is that, to protect us from inflation, our savings must grow at a higher rate than the devaluation of money caused by inflation. Returning to the previous example, if the interest rate is 10% and inflation this year is 7%, we will have appreciated our savings by 3%. Now, if inflation ends up being 12%, then the value of our money will have fallen by 2%.

Remember that it is not enough for the interest rate to be equal to inflation either, because in most countries interest on deposits is subject to tax. Therefore, it is essential that the interest rate is somewhat higher than inflation, to offset the effect of taxation.

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Second option: invest in real estate

The great advantage of these goods is that their price tends to evolve very similarly to inflation.

A very popular option in some countries is to invest part of the savings in real estate, including real estate such as houses, apartments, commercial premises, parking spaces or even unbuilt land. Once acquired, these assets can be made profitable by reselling them after a few years (sometimes after renovations) or by renting them out.

The great advantage of investing in real estate is that its market price usually shows a great correlation with general consumer price indices. In other words, when there is inflation, the price of land tends to rise as well, and also at a fairly similar rate.

In this way, we ensure that our assets are invested in assets that do not constantly lose value. However, when calculating the return on investment, we must also take into account maintenance costs, such as taxes, repairs, etc.

Assets of this type also present another problem, since they are illiquid assets. This means that if we have an economic need and we must transform this investment into money, it will probably take time to sell our property. For this reason, experts usually recommend not investing all of our savings in this type of property.

Finally, it is also important to consider the real estate market situation before investing. Property prices may go up, but if they have been rising at a very significant rate for many years, they are likely to be near the top and plateau soon. If so, it will be much more difficult to make a return on our investment.

Why not invest in the Stock Market?

In Mexico, of the four great alternatives to invest, the Stock Market is the only one that has managed to overcome inflation

Graphic Mexico

Another alternative is investing in equity assets, especially company shares. We can do this by investing directly in the stock market, or by contracting an investment fund with a strong variable income component at the bank.

The great advantage of these assets is that, if companies sell increasingly at higher prices, their income statements improve, and this increases the value of the shares.

However, this option also presents great difficulties. This, not only because it usually requires advanced financial knowledge, but also because of the associated costs (in the form of commissions) and because of the high volatility of the financial markets, which can cause us to end up suffering losses. Also, as with real estate, it is important to know the market cycles and the characteristics of our investment.

In any case, and despite the risks, investing in the stock market is still one of the most attractive options. As we can see in the graph, in the last 20 years in Mexico, stocks have been one of the few investment options that have outperformed inflation. This, to the point that, for every peso invested in 2001, a Mexican in 2021 would have earned an average of 8 pesos.

If your money loses value, change it for another!

Saving in more stable currencies can be a very interesting option, especially if our national currency is constantly devalued

Finally, there are many people, especially in the Hispanic world, who consider an alternative approach on how to protect their money against inflation. If inflation is the loss of value of a currency relative to the things we can buy with it, why not change currency?

Saving in more stable currencies can be a very interesting option to keep our money safe. In Argentina, for example, there are many families who have chosen to diversify their savings and keep part of them in other currencies, especially dollars or euros.

In fact, according to a recent report by the Argentine University of Business (UADE), among Argentines who have savings, 52% decide to protect them by keeping dollars in cash and 28% in the bank. Another noteworthy fact is that cryptocurrencies are already the second most popular savings option, with 30% of the total.

These are the main alternatives to protect our money from inflation. Each one has its advantages and disadvantages, and many people go for a combination of several of them. Therefore, from Economipedia we encourage our readers to find out more about these opportunities in our investment guides and comment on their experience.

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