The state of the current economy has many people concerned about how their savings rate is doing versus inflation. Currently the interest rates on savings accounts are fairly low, hanging in around an average of 2%. The current rate of inflation is crawling towards 4%. So how does the savings rate rank versus inflation?
It is important to understand the major mathematical difference between the two to fully comprehend the relationship they have. Savings rates have a compounding interest structure. If you put money in the bank today and don’t touch it, the interest earned will keep adding to your total nest egg. Interest will constantly be generated on your growing total, hence compounding.
Inflation is just the basic increase of prices over time. If you were to travel back in time to 1962 with a $10 bill in your pocket, you simply had more purchasing power with that money then. That same $10 wouldn’t go nearly as far in today’s economy.
Factoring Interest Rates into the Equation
When the two are combined you can sort of get a picture of future economic events. If a consumer were to place $100 in a bank account today, and earn a solid 5.05% interest rate for a total of 20 years, the total savings account balance would be about $267. The rate of inflation general averages 3%, so imagine that increase over twenty years – today’s dollar would be worth about 54 cents. By combining those two factors, your total savings would really be equivalent to approximately $145.
But it is important to know that it isn’t only the effect of inflation impacting your money, taxes are a consideration as well. Sure, the current balance tips the scales unfavorably but that has not always been the case. Just because Americans aren’t experiencing the savings rates versus inflation balance now, doesn’t mean that the scales aren’t going to tip in our favor again.