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Inflation is at its 40-year high. That means consumers losing purchasing power at a faster than usual pace.
How fast does inflation eat away at your savings? The so-called Rule 72 can help assess its long-term impact.
This rule usually applied to return on investment. This is a calculation that roughly shows how many years it will take investors to double their money at a certain interest rate.
Here’s how it works: Divide 72 by the annual interest rate to determine the amount of time it takes to double your investment.
For example, the mutual fund, which yields 2% per year, will double in 36 years. One with an annual income of 6% will do so in 12 years.
With inflation, the rule works the other way around: consumers can roughly estimate how quickly higher prices (for food, energy, rent, and other household budget items) will halve the cost of their savings.
Consumer price index, a key indicator of inflation, jumped 8.5% in March 2022 compared to the year before, the fastest growth in 12 months since December 1981.
When applied to formula 72, inflation of 8.5% halves the value of consumer money in about 8 and a half years. (Seventy-two divided by 8.5 equals just over 8.47.)
“[The rule] works the same way, regardless of whether you mean the inflation factor – which essentially reduces the purchasing power of your money – or whether you apply rule 72 to increase your money, ”said Charlie Fitzgerald III, a certified financial planner and member. founder of Moysand Fitzgerald Tamayo in Orlando, Florida.
However, there are a few caveats.
First, this rule assumes that inflation will remain elevated (and constant) for some time. It is unclear how long inflation will remain above normal and whether it will reach its peak. There are signs According to economists, inflation may begin to slow.
A healthy economy is experiencing at least some inflation. The Federal Reserve is aiming for a long-term rate of about 2%; central bank began to lift its benchmark interest rate to curb high prices. (An inflation rate of 2% would halve the value of money in about 36 years.)
In addition, rising costs do not affect all households equally. In some families, personal inflation rates may be lower (or higher) than the national average, depending on what they buy.
Anyone who commutes to work and pays for petrol (one of the biggest factors in inflation in March) may experience a rise in prices more sharply than someone who uses public transport, for example.
Wage growth and any earnings on savings also serve to compensate for at least some inflation.