Can you beat inflation?
The Finance and Investment Column
Stabroek News
June 25, 2004
This column provides informative commentary on financial matters
Most people receive income during their lives, the most common form of which is being paid in exchange for work. Each time you get paid you will probably have to spend a large part of that income on expenses such as housing, utilities like power and the telephone, travel and food. If, after meeting your immediate expenses you have some spare cash there are a variety of things you could do with it. You may spend it all straight away on new clothes or on a birthday treat. Or you may decide not to spend your spare cash and save it up to spend in the future. This article examines some of the reasons for personal saving, and how to go about it.
There are many household appliances which you might want for your home such as a television or fridge. Although your spare cash in any one particular month might not be enough to purchase an item like this outright if you saved up over a period of time you should be able to afford it in time. This might seem very elementary, however a similar argument lies behind almost every decision to save; most people save excess cash now so it can be used at a future point in time when it is needed. Even if you don't have anything specific in mind to spend it on, it is always a comfort to have some excess cash which could be used if the need arises.
So having made the decision to save how should you go about it? One possible way is to keep banknotes eg in a shoebox or "under the mattress." Keeping physical notes has the advantage that you will have instant access to your savings, but often involves significant disadvantages. Firstly, you will likely want to find a secure place to put it which may involve buying a safe or you may be worrying about whether your cash will be there when you get back. Another is the fact that inflation erodes how much your dollar will buy; if prices go up by 5% each year then a soft drink which cost $100 a year ago will now set you back $105. Your $2000 dollars you left under the mattress which would have bought 20 soft drinks a year ago would only buy 19 (2000/105) today.
Fortunately, an entire industry has developed from the business of keeping people's cash secure - and that industry is banking. Banks are usually quite accommodating and will let you deposit your cash in an account with them. When you deposit money in the bank you are lending the bank your cash. Since the bank benefits from having your cash to use and you cannot use your cash until you withdraw it, the bank usually pays you some interest on your balance. So barring the bank going bust, you would be better off with your money in the bank than under the mattress since your account will grow with interest, whereas keeping the cash in a box it will not grow at all!
But even with your money in the bank your savings may not be safe in real terms. If the rate of interest paid on the account is less than the rate of inflation then your dollars would still be able to buy less in a year's time than they could today. Say you are getting 4% interest from the bank. As in the example above, if prices go up by 5% each year then a soft drink which cost $100 a year ago will now set you back $105. Your $10,000 dollars you deposited in an account earning 4% interest will have grown to $10,400. However it still would only buy 99 (10,400/105) soft drinks today when a year ago it would have bought 100.
Because inflation erodes the purchasing power of savings it is particularly damaging to those whose income does not necessarily increase when prices go up. The classic example would be a pensioner on a fixed income. With the exception of the NIS the majority of pensions schemes in Guyana do not offer automatic increases to pensions in line with inflation once in payment. Someone who is receiving a pension which can cover the bills today may find in five or ten years time that they can no longer make ends meet.
The following table shows the amount of goods and services which a fixed monetary amount can purchase after a number of years as a proportion of the amount which it could buy today.
As the table shows, after inflation of 10% for 25 years the same amount of money can buy less than 10% of what it can today. Even a modest 5% rate reduces purchasing power by almost 40% after ten years. The next time you are saving money think whether the growth in your savings is keeping pace with inflation. If it is not it may be time to consider alternative ways of investing your savings.