How money shrinks

At the same time that you’re trying to grow your money by saving and investing it, there’s a force in the economy that is shrinking your money. It’s called inflation.

You may have noticed that things now cost a lot more than they did when you were a kid. A soda that you remember paying 50 cents for is now a dollar. That means those two quarters in your pocket that used to be able to quench your thirst just can’t do it any more. Their buying power has been eroded by the rising price of everything, and those rising prices are what economists are talking about when they discuss inflation.

The more prices rise, the more you have to earn to keep up. For instance, if you put your money in a savings account earning 2% per year, but prices also rose 2% by the end of the year, your bank statement would show a higher dollar amount, but you wouldn’t be able to buy any more with it than you could have bought before. And if inflation went up 3%, as it sometimes does, you actually lost ground to inflation and no longer could purchase what you once could.

Inflation makes a greater difference with long-term goals, since prices don’t tend to change dramatically from year to year, but the total effect can be staggering. So the further ahead in the future your goals are, the more you have to plan to compensate for the effects of inflation.