Inflation: Impact on Your Finances and How to Protect Your Money

Inflation is an economic phenomenon that, although it often seems distant, directly affects people's personal finances. With every purchase at the supermarket or bill paid, its impact can be felt. But what exactly is inflation, and how can one safeguard money against its consequences? Below is a concise and clear explanation of this important economic topic.

What is inflation exactly?

Inflation is defined as the generalized and sustained increase in the prices of goods and services within an economy over a specific period of time. Essentially, this indicates that the purchasing power of money decreases. What could once be bought with a specific bill now yields less.

This phenomenon causes that with the same amount of money, fewer goods and services can be purchased than before, complicating budgeting, saving, and investing, given that reference prices are in constant flux.

Main causes of inflation

Inflation does not arise spontaneously; it is the result of various economic factors. The most common causes include:

1. Demand-pull inflation: This occurs when the amount of money circulating is higher than the supply of goods and services. This imbalance between demand and production capacity leads to price increases.
2. Cost-push inflation: This happens when production costs rise, whether due to increases in raw material prices (such as oil, gas, or wheat), labor costs, or taxes. To maintain profit margins, companies pass these additional costs on to the final consumer.
3. Expectational (or self-fulfilling) inflation: Sometimes, inflation occurs simply because of an anticipation of its occurrence. If producers believe prices will rise, they may increase their prices now as a preemptive measure, which ends up confirming their own predictions. Similarly, workers may demand wage increases due to anticipated inflation, which can lead companies to raise their prices as well.

How is inflation measured?

Inflation control is carried out through indicators such as the Consumer Price Index (CPI). In Spain, the National Statistics Institute (INE) is responsible for compiling this index. It creates a "shopping basket" that reflects the most consumed goods and services by households. This organization reviews the prices of thousands of products monthly in various stores across the country to calculate the cost variation of this basket.

For example, if it is reported that monthly inflation was 0.5%, it means that the average price of that basket of goods and services increased by 0.5% compared to the previous month.

Real impact on your wallet and savings

The most tangible effect of inflation is the loss of purchasing power. This means that salaries become less effective, and more money is required to maintain the same standard of living. However, the impact extends beyond that:

• Erosion of savings: One of the most significant risks. If you have money saved under the mattress or in basic savings accounts that do not earn interest, inflation reduces its real value. For example, with an annual inflation rate of 3%, 100,000 euros saved today would be worth only 85,873 euros in purchasing power in five years. Doing nothing with the money means losing purchasing power for sure.
• Impact on debts: Inflation acts as a double-edged sword. While it benefits those with fixed-rate debts, as the real value of their debt decreases over time, it harms creditors. Additionally, if one has variable-rate debts, it is likely that rising interest rates to combat inflation will increase monthly payments.
• Generation of uncertainty: Price fluctuations make long-term financial planning difficult for both individuals and companies, discouraging saving and investment.

Strategies to protect your money from inflation

Despite the uncertainty that inflation can generate, there are effective strategies to mitigate its impact. Here are some recommendations:

1. Invest in instruments that outpace inflation: The goal is to achieve a positive real return, that is, to generate profits that exceed the inflation rate. Some alternatives include:
   • Stocks: In the long term, investing in solid companies has proven to be one of the most effective ways to outpace inflation.
   • Real estate: Properties and rents tend to increase in value in line with inflation, especially those linked to indices like the UF in Chile or similar ones in different countries. Real estate investment trusts (REITs) are an accessible option for many.
   • Commodities: Assets like gold or oil can represent a refuge during periods of high inflation, although their value can be volatile.
   • Inflation-linked bonds: These debt instruments are adjusted to protect the investor from rising prices.
2. Diversify investments: The saying "don't put all your eggs in one basket" is fundamental. Mixing different types of assets (fixed income, equities, real estate) helps mitigate risk.
3. Review the budget: It is essential to identify areas of spending where price increases are most felt and seek ways to adjust consumption.
4. Avoid debts with variable interest rates: In an inflationary environment, central banks tend to raise interest rates, which will make variable debts more expensive. Whenever possible, opting for fixed rates is advisable.

Inflation is an unavoidable economic phenomenon, but with good knowledge and a sound financial strategy, it is possible to protect one’s assets. This ensures that personal effort and savings continue to grow over time.

If you wish to delve deeper into financial topics, feel free to explore more content on this blog.