Is Your Cash Keeping Pace With Inflation?
For the entire month of June, I have been trumpeting about the value of saving money. But keeping your money in your savings account might not be doing it any good. In fact, you might actually be losing money.
Something that affects everyone’s cash position is inflation. I try to explain inflation by using McDonald’s value meals. When I was in high school, a McDonald’s branch opened near our school. Being high school kids on allowance, my friends and I will always get the Burger McDo value meal which sold at P19.00. Now, the same meal sells for P60.00. That’s a 200% increase. That’s inflation at work. It was the same burger 10 years ago but now it sells at a higher price.
Every year, for the past decade, prices have been rising at a rate of at least 4% per annum. There was even a year when the average inflation rate was 12%. For example, a McChicken sandwich selling at P100.00 a year earlier will sell at P112.00 the following year.
Let’s say you saved that P100.00 in a bank instead so that you can buy a McChicken sandwich the following year. If the interest on your savings is 1% per annum, then after one year, your savings will earn 1 peso and you’ll have P101.00. Now, since you “earned” something, that earning will be subject to a 20% withholding tax on income so 20 centavos will be deducted from your 1 peso. This leaves you with an end amount of P100.80. The thing is the McChicken meal is now P112.00 because of inflation. So you still need P11.20 to pay for it. You should have bought the sandwich the year before.
Am I saying that you just keep on spending now because it’s gonna be expensive in the future anyway?! No, of course not! I’m all for saving money, but you should save for a specific goal, and that is to set up your emergency fund worth 3-6 months of your living expenses. Anything in excess of that should be invested.
Your emergency fund should be topped up regularly (for example, every time you get an increase, or every year in consideration of inflation) and you should make your investments work in such a way that they either keep pace with inflation or grow faster than inflation.
For the month of July, we will be discussing how you can build up your savings and at the same time move to higher earning investment vehicles so that we can protect the value of your hard-earned income from the eroding effects of inflation, and also make your money work for you so that you actually earn something out of it.