Inflation and How It Can Make You Poorer

Very many of us especially in this part of the world recognize that the word “inflation” does not mean anything good in every sense mostly when it relates to the economy of the country. However, this is not always the case as sometimes a little inflation in an economy can be beneficial to the nation. 

I had sometime asked a primary school boy what inflation is and to my surprise, he gave me an answer that was not wrong. He said, “Inflation is when the price of everything in the market goes up”.  Although his definition was not “technical”, he was not far from the truth. 

For the sake of this post however, we will focus on explaining what Inflation truly is, its negative effects mostly and how it can in fact make you poorer. Yes you read that right just in case you didn’t know, inflation can actually make you poorer. 

Inflation according to economists is a general increase in prices and fall in the purchasing value of money. Inflation occurs mostly when there is excessive demand for products in the market. In other words, it is a sustained increase in the general price of goods or products. 

Let us break it down using examples. 

You remember during the Coronavirus crisis, the demand for Personal Protective Equipment (PPE) such as hand sanitizers and masks surged. People were willing to pay more for these protective products and the price for these items went through the roof!? 

Also another form of excess demand happens when there is a large amount of money in the economy, just like saying when more money is chasing the same amount of goods? That’s what inflation is. 

Now that we have explained what inflation is, let me show you how it can negatively affect you and make you poorer in the process. Even though the face value of your money does not change; it has less purchasing power and is less valuable due to inflation. With higher inflation, your money becomes worth less every year.

• It Increases your cost of living

The most direct impact caused by inflation is the increase in basic consumer products in the country. You would realize that the money you spend on groceries and even gasoline as well as rent has gone up and you will only be able to afford lesser of those items. If you must buy more to maintain your former living standard, then you would have to be spending more on these items thereby increasing your living cost.

 

• It reduces your real wages

Another effect inflation can have on you is the fact that it reduces your real wage in that, since your cost of living increased, you will spend more to cover your basic needs and most likely, your wages will not catch up with the inflation immediately. So even if you end up taking the same salary home, inflation already has an impact on it that will end up making your salary look like a pay cut.

 

• It causes your investments to be smaller

Returns on Investments (nominal returns) are calculated without taking into consideration inflation. It is possible that you could still be losing money with a positive return on your investment. An example is if the return on a bond portfolio is 3% annually but the rate of inflation is 4%, your purchasing power actually decreases by 1% every single year which means that you are still losing money because while you will have 3% more in the bank, your money will worth 1% less in the stores and that’s not very healthy and this is why a high inflation rate can shrink your investment return without you even noticing it. 

This is how inflation can cause you to become poorer and to learn more about how you can secure your savings from inflation, click here.   

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