How inflation affects your savings
Say a movie ticket cost $5 in 2000, and in 2020, that same movie ticket costs $10. This doesn't mean $5 would grow to $10. It means that your $5 — if you stuck it under a mattress for 10 years — would only buy you half of a ticket in 2020.
If the amount of money you have or make stays the same, it will buy you less as time goes on. That’s due to inflation, which can have a negative impact on your purchasing power, or the amount of goods or services your money can buy.
If you want the money you save to keep pace with inflation — or better yet, outgrow it — you need it to gather a lot more than dust while you pass the time.
Investing allows you to accumulate more money with the dollars you save. If you earn a 6% average annual return — a fairly conservative goal, given that the stock market has historically posted an average annual return of around 7% after inflation — $5 invested back in 2000 could be worth $16 today, about enough to buy 1.5 of those movie tickets. Invest a larger amount — say, $10,000 — and it will really start to snowball: $10,000 invested in 2000 could be worth over $32,000 today.
Keep in mind that investing in the stock market is for long-term goals that are at least five years away. If you need your money before that, you're better off stashing it in a high-yield online savings account.
» Ready to start making your money grow? Check out our picks for the best brokers.
How to calculate inflation rate
To calculate the rate of inflation, you’ll need a start date, an end date, and a chart of the Consumer Price Index. First, subtract the CPI of the start date from the CPI of the end date. Then, divide that number by the CPI of the start date. Multiply this number by 100 and add a percent sign, and there’s the inflation rate for that period.
1990 CPI = 130.7
2010 CPI = 218.056
Equation: ((218.056-130.7)/130.7) x 100
So, we have 66.837% inflation between 1990 and 2010.
To see how inflation affects the value of $1, first divide the inflation rate by 100. Then, multiply that number by $1 (or any starting dollar amount you wish). Then add that number to your dollar amount.
((66.837/100) x 1) + $1 = $1.67
((66.837/100) x 5) + $5 = $8.34
In this instance $1 in 1990 had the purchasing power of $1.67 in 2010, and $5 in 1990 had the purchasing power of $8.34 in 2010.