On Inflation And Your Emergency Fund

I recently talked about one of the reasons why people want to invest their emergency fund. You can read all about it here. Now, I’m gonna address the inflation argument, because it’s gonna have the shorter response and is a concern rooted in what actually happens.

Essentially, inflation is the increase in prices coupled with a general fall in the purchasing power of a currency. Here’s an example: $1 today might buy you a candy bar, but the next year that $1 may only buy you 3/4ths of that same candy bar, and even less as each year passes. That’s how inflation works, and every year, the purchasing power of your dollars diminishes.

In the US, the inflation rate has been below 2% for quite some time, while the highest APY for high-yield savings account is hovering around 0.65% (as of the publishing of this post). So yeah, the more money you keep in savings accounts, the more that inflation will eat into it. But here’s the thing: For any short-term needs, this does not matter! Why? Because the rate of inflation is really low, over a long period of time you’re going to use that money, and your investments will (or should, if done properly) greatly outpace anything you have in savings.

Here’s the thing about the emergency fund: it’s not meant to really grow like an investment in the stock market would. It’s meant to cover your butt whenever an emergency pops up or when “Life Happens”. An emergency fund is like insurance (that you pay yourself) and any losses due to inflation are essentially a “premium” of sorts to protect yourself in the short-term (while your invest for the long-term).

If you want a better explanation of why inflation doesn’t matter for short-term needs, check out a wonderful post from the personal finance blog, Of Dollars and Data, on the best way to save for a big purchase. Long story short, as with saving for a big purchase, the impact of inflation on your emergency is small.

Let me know whether or not you agree in the comments. If you would like to share a story, please feel free to do so!