Do you ever feel like your money isn’t working hard enough for you? If you’re keeping your savings in a low-yield savings account or under your mattress, you might be missing out on an opportunity to grow your wealth.
Inflation can eat away at the purchasing power of your money over time, which is why investing can be a powerful tool to help you keep up with or even surpass inflation. In this article, we’ll explore why investing is so important for protecting and growing your wealth in the face of inflation.
Why should I invest?
Saving part of your paycheck is a good start to a healthy financial future. For very short-term goals like buying concert tickets or a new phone, a bank savings account is a good option. But money that sits in a bank account, earning very little interest, is going to have a hard time holding its value over anything but the shortest of time periods. That’s because inflation eats away at the value of our money.
Most people are familiar with inflation — a measure of how quickly the prices of goods and services are rising. As prices rise, the value of your money drops, because you can buy less with the same amount of money. Sometimes we enter a period when prices of all goods and services are rising. At other times the prices of only a certain group of goods and services rise: maybe a tropical storm has raised the price of bananas this month, or a war has impacted the oil supply.
Higher energy prices in particular can have a ripple effect on the prices of many other goods and services that need energy to function. Think of airlines or food prices that can be impacted through higher transportation costs. When these scenarios happen, higher prices mean your money can buy less.
One of the key reasons to invest is to help make the value of your money rise as much as, or perhaps more than, inflation.
Let’s illustrate with an example: Imagine you have $10,000 in your bank account and you’re thinking about some condo renovations that will cost $15,000. You decide to wait until you have the full amount, and you know it will take you a year to save another $5,000.
One year later, you have $15,000, but when you go to hire the contractor, they quote you a new price of $15,300. A 2% inflation rate has affected their costs and they need to charge more just to keep up. The cost of what you’re looking to purchase has increased, but the money that you’ll use to pay for the service hasn’t increased to the same extent.
This example is just over a one-year period. Imagine what happens over the 30-plus years many people have until retirement. With just a modest 2% inflation rate, that contractor could be charging you over $27,000 for those renovations in 30 years. Not to ignore the fact that there’s a much greater chance your condo will need renovating in 30 years.
Inflation is that sneaky thief that steals the value of our money over time. The average annual inflation rate in Canada from 1970 to 2022 was 3.9% a year, but more recently from 2000 to 2022, it’s averaged 2%.1 The high and low of that range has been 12.5% in 1981, to 0.2% in 1994.2 In the recent past, Canadians had become used to a relatively low inflation environment, but inflation picked up as we emerged from a global pandemic. Because the inflation rate is affected by so many factors, it’s difficult to accurately predict its future path — but looking at past averages can provide some guidance.
Growing your money to battle inflation
The way you invest your money goes a long way to determining whether you’ll keep up with inflation. Some investments might make you more money, but they may also come with a higher chance of losing money. In other words, each investment choice has its own level of potential gains and potential losses — that is, their predicted return and risk. It’s important to understand these differences so that you can choose which investments are right for you.