Business & Finance

How Inflation Erodes Your Savings (And How to Calculate It)

Published on September 19, 2025

You've likely heard the term "inflation" on the news, but what does it actually mean for your wallet? In short, inflation is the silent thief that reduces the purchasing power of your money over time. The $100 in your savings account today will buy you less in five, ten, or twenty years. Understanding this concept is absolutely essential for long-term financial planning.

What is Inflation and Purchasing Power?

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. If the annual inflation rate is 3%, it means that on average, a basket of goods that cost $100 last year will cost you $103 this year. Your money has effectively become less valuable.

The Formula for Calculating Inflation's Effect

To see how inflation will affect your money in the future, you can use a variation of the future value formula:

Future Value = Present Value × (1 + Inflation Rate)^n

Where:

• Present Value is the amount of money you have today.
• Inflation Rate is the average annual rate of inflation.
• n is the number of years into the future.

For example, to find out how much money you'd need in 20 years to have the same purchasing power as $50,000 today, assuming a 3% inflation rate:
Future Value = $50,000 × (1 + 0.03)^20 = $90,305.

Why This Matters for Your Financial Goals

Understanding inflation is not just an academic exercise; it's critical for realistic financial planning:

• Retirement Savings: The retirement corpus you calculate for today's expenses will be woefully inadequate in the future. You must factor in inflation to determine your true retirement number.
• Investment Returns: To build wealth, your investments must generate a "real return"—a return that is higher than the rate of inflation. If your investments grow at 5% but inflation is at 3%, your real return is only 2%.
• Setting Goals: When saving for a long-term goal like a child's education or a house down payment, you must estimate the future cost of that goal, not the current cost.

Conclusion

Inflation is a constant and powerful force in finance. By acknowledging its effects and using tools to calculate its impact, you can set more realistic financial goals and develop investment strategies that ensure your money grows faster than it loses value.