You probably already know that each paycheck you earn has deductions for both state and federal taxes before you can spend any of your hard-earned money.
You may even know how some of those taxes are spent–on infrastructure, medical care, and education, for example.
But what if there was another tax you were paying without even knowing it?
This is how people often describe inflation.
Is Inflation a Tax?
The simple answer is, no. Inflation is not a tax.
In simplest terms, inflation refers to a decrease in a currency’s spending power.
To be clear, inflation refers to a reduction in buying power across all goods and services, not just some or among a certain industry. When some prices go up but others don’t – or even fall – that is known as a relative price change.
That is a completely different phenomenon, but many people confuse it with inflation. This is an important mistake to avoid, though. For the most part, you can choose to remain unaffected by a relative price change. Just don’t buy the product or buy a competitor’s product that costs less.
You can even wait until the price drops again before making your purchase.
On the other hand, there is nothing you can do about inflation. If you spend money – which we all do – inflation is going to be an issue.
Protecting Your Income Against Inflation
Moderate inflation is often good for the overall economy as it can stimulate demand. However inflation might not be so friendly for you savings, especially the ones stored in the form of cash.
If inflation is higher than the interest rate you earn in a savings account–the average annual interest rate is .07%— you are essentially losing money.
Inflation doesn’t have to hurt your savings, though. By investing your money, you are effectively trading savings for other type of assets, like stock, bonds, or funds. Some of these investments may be less affected by inflation than cash sitting in a savings account.
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