Why saving in a bank account means losing money
Inflation is the ongoing loss of purchasing power of money. At three percent a year, purchasing power roughly halves in about 23 years, even though the number in your account never changes.
Ask someone what a bread roll cost twenty years ago. The price didn't change because the roll got better, it changed because money got worse.
Inflation measures exactly that: how much less you get for the same amount. Two percent sounds harmless, but it acts again every year on an amount that's already shrunk. That's compound interest, just running in reverse.
A handy rule of thumb is the number 70. Divide 70 by the inflation rate, and you get roughly the number of years until your purchasing power is cut in half. At 2 percent, that's 35 years; at 3 percent, 23; at 7 percent, only ten.
That doesn't mean you should invest everything. Your emergency fund stays in the bank, and its loss of purchasing power is the price for being there. It only means: money you won't need for thirty years is guaranteed to lose value in a bank account. Invested, it might.
Inflation is measured against a basket of goods meant to represent average spending. That implies an important caveat: the published rate is an average across all households. Anyone spending an above-average share of their income on housing and energy typically experiences a higher personal inflation rate than the official figure.
For investment decisions, what matters is the real return: the nominal return adjusted for inflation. Exactly, r_real = (1 + r_nominal) / (1 + π) − 1. For small values, the approximation r_real ≈ r_nominal − π is close enough. A savings account paying 2 percent interest amid 3 percent inflation delivers a real return of roughly −1 percent, despite the positive interest credit.
The half-life of purchasing power follows from ln(2) / ln(1 + π). At 3 percent, that comes to 23.4 years. The rule of thumb using the number 70 is an approximation of this formula, since ln(2) ≈ 0.693. For rates below roughly ten percent, the deviation is negligible.
Summary
- Inflation works like compound interest, just against you.
- 70 divided by the inflation rate gives the years until purchasing power halves.
- Only the real return after inflation actually tells you anything.
Did you get it?
At 3.5 percent inflation, how long until purchasing power halves?
About twenty years, since 70 divided by 3.5 is 20.
What's the real return at 2 percent interest and 3 percent inflation?
Roughly minus one percent. Despite the interest credit, you're losing purchasing power.
Why does your personal inflation rate often differ from the official one?
Because the official rate measures an average basket of goods, and your own spending pattern differs from it.
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