If you leave your savings in a low- or no-interest account, such as a checking account, you could be losing money without realizing it. Inflation causes your money to lose value over time because you have to spend more to cover expenses and purchases.
Fortunately, the best high-yield savings accounts offer interest rates that beat inflation. But that may not last forever, especially since the Fed plans to cut its interest rates soon. We’ve explained how current high-yield savings accounts beat inflation rates and what Fed rate cuts mean for your savings.
How does inflation affect savings?
To understand how high-yield savings accounts beat inflation, you first have to understand what inflation is. Patrina Dixon, CFEI, RFC, CEO of It’$ My Money, says inflation is the rate at which the prices of goods like gasoline and groceries rise.
That means your dollar is worth less over time because you have to spend more to buy the same goods as you did last year. If you don’t earn interest on your savings by putting them in a high-interest savings account, CD, or money market account, they slowly lose value and purchasing power.
There are several ways to measure inflation. The most popular is the Consumer Price Index, which uses average price changes from one year to the next to determine inflation.
However, there are other ways to measure inflation. The Federal Reserve, the central banking system of the United States, uses the PCE index, or Personal Consumption Expenditures Price Index, for its inflation calculations. They say they use the PCE over the Consumer Price Index because the PCE adjusts more quickly to changes in spending behavior. According to the Fed’s July 31 meeting, the PCE is currently around 2.5%, meaning that prices for goods in general have increased by about 2.5% year over year.
Currently, many high-yield savings accounts offer much higher interest rates than they used to. “For high-yield savings accounts, we see average rates between 4% and 5%, depending on the financial institution. And while inflation is relatively high right now, you’re still getting an advantage if you’re saving or holding a savings position,” says Rianka R. Dorsainvil, CFP, founder and chief wealth advisor at YGC Wealth.
While this is great for savers hoping to combat inflation, interest rates may not stay at this high level for long.
When will the Fed cut interest rates?
The Fed has said it will cut interest rates when inflation reaches 2%. Currently, savings rate forecasts suggest that the Fed will cut rates soon. The CME Fedwatch tool predicts a probability of over 90% that the Fed will cut rates at its next meeting on September 18.
When the Fed cuts interest rates, it’s likely that savings account rates will also fall. While we can’t predict the exact rate changes, there’s a chance that competitive high-interest savings accounts won’t be able to beat inflation as well as they once did.
Still, there are ways to prepare for the future, no matter what it brings. Dorsainvil says it’s important to take a long-term approach to balancing risk with your personal financial goals. “Inflation may go up, inflation may go down, but it’s just like, OK, what tools and resources do I have today that I can make sure my financial goals today are attainable and my financial goals tomorrow are attainable?” Dorsainvil says.
Dixon says that while high-interest savings accounts are good for short-term savings like emergency funds, investing can be a good long-term strategy — as long as you understand the risk. She says that $100 invested “can grow to a lot more than $100, but it can also fall to zero.” In comparison, you’re very unlikely to lose money you put into a high-interest savings account, but the interest you earn won’t be as high as what you could get by investing.
Dixon also says you can invest and use a high-yield savings account at the same time. “You can save and invest. It’s not one or the other,” Dixon says. By investing and using a high-yield savings account, you have access to liquid funds in emergencies and can still outperform inflation with the money you put in a brokerage account or other investment.
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How does inflation affect savings? FAQ
People with savings are affected by inflation because their savings lose value over time due to inflation. Unless your savings are in a high-interest savings account, the current inflation rate could exceed the interest you receive on your savings.
Inflation affects the value of money by causing it to lose value and purchasing power over time.
Using a high-yield savings account can help you protect your savings from inflation, as current interest rates on high-yield savings accounts are higher than current inflation rates. You can also use CDs to save for specific savings goals, or you can invest money, which involves more risk but offers the chance of higher dividends.
You could lose money in a savings account if your account’s interest rate is lower than the current inflation rate. Other ways to store your savings include money market accounts or CDs if you don’t expect to need your money before the CD term expires.
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