Here’s a simple way to see how inflation is eroding your long-term savings
Sean Gladwell | moment | Getty Images
Inflation is at a 40-year high. This means that consumers are losing purchasing power faster than usual.
How quickly will inflation eat away at your savings? The so-called Rule of 72 can help gauge its long-term effects.
This rule of thumb applies to investment returns in general. It’s a back-cover calculation that approximates how many years it takes investors to double their money at a given interest rate.
Here’s how it works: Divide 72 by the annual interest rate to determine the time it takes for an investment to double.
For example, a mutual fund that returns 2% per year will double in 36 years. One with a 6% annual return will do so in 12 years.
With inflation, the rule works in reverse: consumers can gauge how quickly higher prices (for groceries, energy, rent, and other household items) will halve the value of their savings.
The consumer price index, a key indicator of inflation, rose 8.5% year on year in March 2022, the fastest 12-month gain since December 1981.
Applying the Rule 72 formula, an inflation rate of 8.5% halves the value of consumer money in about 8½ years. (Seventy-two divided by 8.5 equals just over 8.47.)
“[The rule] works whether you’re implying an inflationary factor — essentially reducing the purchasing power of your money — or using the Rule of 72 to grow your money,” said Charlie Fitzgerald III, a certified financial planner and founding member of Moisand Fitzgerald Tamayo in Orlando , Fla.
However, there are a few caveats.
First, this rule assumes that the inflation rate will remain elevated (and constant) for a while. It is unclear how long above-average inflation will last and whether it has peaked. According to economists, there are signs that inflation may be slowing.
A healthy economy experiences at least some inflation. The Federal Reserve is targeting a long-term interest rate of around 2%; The central bank started raising its benchmark interest rate to curb high prices. (An inflation rate of 2% would cut the value of money in half in about 36 years.)
In addition, rising costs do not affect all households equally. Some families may have a personal inflation rate that is lower (or higher) than the national average, depending on what they buy.
Someone who drives to work and pays for gas (one of the biggest contributors to inflation in March) may experience higher prices more clearly than, for example, someone who uses public transport.
Wage growth and any returns from savings also serve to at least partially offset inflation.
https://www.cnbc.com/2022/04/27/heres-a-simple-way-to-see-how-inflation-erodes-your-long-term-savings.html Here’s a simple way to see how inflation is eroding your long-term savings