How Inflation Should Change Saving Habits

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Most savers are tearing their hair out over low yields on savings accounts and certificates of deposit. But maybe things aren’t as bad as they seem, despite the persistently low inflation rate.

For the period ending July 31, the consumer price index rose a mere 1.2%, while the core rate was up just 0.9%, the lowest it had been since 1966, according to the Labor Department. The core rate excludes food and energy costs, which are so volatile they distort the overall rate.

Over the long term, inflation averages around 3% a year, but it can vary widely. In 1979, it was more than 13%; in 2008 only 0.1%, and in 2009, it was 2.7%.

Savers should examine yields in relation to inflation. “Real” interest earnings are the interest rate minus the inflation rate, and the real rate reflects the actual growth in the buying power of every dollar you’ve socked away.

So what do the latest inflation figures mean for your savings? If you’re willing to tie your money up for four or five years, you can actually make money in a CD on a real, post-inflation basis. Four- and five-year CD yields average 1.6% and 1.9%, respectively, according to the BankingMyWay survey.

Beating inflation by a single percentage point or less won’t make you rich, but no one ever got rich with bank savings, anyway. CDs and savings accounts are meant for safe-keeping, with the FDIC insurance guaranteeing your money states put. Any interest earnings are gravy.

Going further, bank savings have always been best for rainy-day funds, ordinary living expenses or diversification — a stabilizing force in a portfolio that includes some risky holdings. To really grow your money on an after-inflation basis, you’ll need to take more risk, investing in stocks, long-term bonds or other securities.

Because inflation is so important, it’s best not to take the figures at face value. The CPI is a national average based on a basket of products and services, and not many consumers spend money in exactly the same proportions the government assumes. If you’re spending a lot on health care or college tuition, your costs probably went up faster than the CPI. If not, they might have gone up more slowly, or even fallen.

So it’s worthwhile to think about your “personal inflation rate,” based on your own spending pattern. MyInflationRate.com offers a series of tools to help.

One of these is a list of goods and services featuring the most extreme price swings. In the 12-month term that ended June 30, for example, the most inflationary items, with prices rising from 14% to more than 17%, were airline fares, lamb and mutton, used vehicles, fuel oil and delivery services. The biggest price declines, from 8% to nearly 25%, were in furniture, computers, women’s dresses, video equipment and televisions.

The site’s Inflation Index Generator can be used to compile a list of items you spend money on, and the Inflation Rate Calculator will then use that list to figure your personal inflation rate. By playing with these numbers you can get a sense of whether your cost of living rises faster or slower than the CPI. More importantly, this insight can help you plan for future expenses such as retirement.

If you find, for example, that your retirement costs are likely to rise faster than the long-term average of 3%, you could compensate by taking more risk with stocks and bonds, hoping for bigger returns or by increasing the amount of money you set aside in bank savings and other holdings.

The Retirement Income, Retirement Planner and Savings Goal calculators will show what it will take to reach your goal.

Of course, even if you do opt for safety, it pays to use the BankingMyWay shopping tool to unearth those above average deals.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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