Inflation has been in the news a lot lately, and for good reason. In October, consumer prices were up 6.2% from the previous year. And while this recent bout of inflation has been quite extreme, the reality is that inflation is a perennial threat to the purchasing power of consumers.
There are some things you can do if inflation is making it difficult to keep track of your bills right now. First, you can try cutting back on non-essential expenses, like hobbies and entertainment (this is not an easy thing, but potentially necessary if sustaining those expenses means going into debt). You can also try to get additional help to increase your income and keep up with the rising cost of living.
But there is another important step you can take to protect yourself from inflation over the long term: invest in a brokerage account.
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When you put money in a brokerage account, you can invest that money so that it grows to a larger amount over time. If your investments are performing well, you could earn a high enough return on your brokerage account to exceed inflation. On the other hand, if you leave your money in a savings account, you may not be receiving enough interest to beat the rate of inflation.
Right now, even the best savings accounts pay somewhere in the range of 0.50% interest. Granted, rates are exceptionally low right now, but even if they climb to 1% or 2% in the next few years, annual inflation is usually around 3%. If you only earn 1-2% interest on a savings account each year, you won’t exceed inflation in the long run.
Now, let’s say you invest in stocks through your brokerage account and your portfolio generates an average annual return of 7% or 8%. It’s actually a little below the historical stock market average, and it represents years when the market is doing a lot better than its average return, but also a lot worse. If the general inflation rate over the next 20 years, say, stays at around 3%, but you earn more than double that return on your brokerage account, you will fare financially.
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Of course, investing in a brokerage account is not without risk. When you buy stocks, there is no guarantee that you will get the returns we just used in our example, or that you will not lose money. But if you load up on a diverse mix of stocks and hold them for many years, there’s a good chance you’ll get a decades-long financial lead.
Exchange one risk for another
Some people don’t invest in a brokerage account because they think it’s too risky. But it’s important to realize that if you don’t take this risk, you will assume another risk: losing purchasing power in the face of inflation. If you haven’t opened a brokerage account yet, you might want to start researching your options and investing your money to give yourself that edge.