Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Eats Your Emergency Fund
Transcript
- Lucas: So Luna, you know how we always say inflation is the silent tax on everything? Well, today I want to talk about the one place where it might hurt the most, and that's your emergency fund. Luna: Oh, that's a good one. Because you think it's safe in cash, but it's actually losing value every day, right? Lucas: Exactly. And here's the thing, we've talked about bond ladders, HSAs, even wine collections in past episodes. But the emergency fund is the foundation of everyone's financial plan, and it's often the most overlooked when it comes to inflation. Luna: And if you've ever found value in how we break down these money topics, and you've thought about supporting the show, there's a way to do that. It's buy me a coffee dot com slash fexingo. Every little bit helps keep these conversations going, and it's like buying us a coffee while you think about your own financial moves. Lucas: Yeah, we really appreciate that. And speaking of coffee, that's not a bad metaphor for how inflation adds up. But let's get back to the emergency fund. So, what's the typical advice? Three to six months of expenses, right? Luna: Right, but that advice is based on the assumption that your money holds its value. And with inflation, it doesn't. Lucas: Let's put some numbers on this. The latest CPI reading, from July, is at 332.8, up from 332.57 the month before. So we're still seeing inflation, even though it's slowed from the peak. But here's the thing, the average high-yield savings account is paying around four to five percent these days. And that's great. But if your personal inflation rate is higher than that, you're still losing ground. Luna: And your personal inflation rate might be higher than the national average, especially if you're in a city with high rent or you're paying more for healthcare. Lucas: Exactly. So let's say you've got ten thousand dollars in an emergency fund. At a four percent return, that's four hundred bucks a year. But if inflation is running at three point five percent, your real return is only about fifty dollars. And if inflation spikes, like it did in 2021 and 2022, you could be looking at negative real returns for a while. Luna: So what are people supposed to do? Just accept that their safety net is shrinking? Lucas: No, and that's where we can get strategic. One option is to keep a portion of your emergency fund in I Bonds. These are savings bonds that adjust for inflation. The composite rate is based on a fixed rate plus the inflation rate, so they protect your purchasing power. Luna: But there's a catch, right? You can't redeem them for the first twelve months, and there's a three-month interest penalty if you cash out before five years. Lucas: Right, so you don't want your entire emergency fund in I Bonds. But you could create a ladder. Put a month's worth of expenses in I Bonds each year, and over time, you'll have a portion that's always maturing, giving you access while still getting that inflation protection. Luna: That's a smart way to think about it. And what about CDs? With the Fed holding rates around three point six three percent, you can lock in a decent rate for six months or a year. Lucas: Yeah, CD ladders are another tool. The idea is to stagger maturities so you always have a CD coming due. But you have to be careful about early withdrawal penalties. For an emergency fund, you want liquidity, so maybe only use CDs for the 'second tier' of your emergency savings. Luna: Second tier? What does that mean? Lucas: Think of it this way. You don't need all your emergency money instantly. If you lose your job, you might need cash for the first month, but you probably have a few weeks before that first month is over. So you can have a core emergency fund in a high-yield savings account, and then a second tier in short-term CDs or I Bonds that you can access with a little notice. Luna: That makes sense. It's about matching your liquidity needs with your investment time horizon, even within your emergency fund. Lucas: And there's another angle. We often think about emergency funds in terms of nominal dollars, but you should also think about the real purchasing power. That means you might need a bigger nominal balance to cover the same expenses in the future. Luna: So if your expenses are going up, your emergency fund needs to go up too. How do you calculate that? Lucas: You can use the CPI to adjust. For example, since 2020, the cumulative inflation has been around twenty percent. So if you had a ten thousand dollar emergency fund in 2020, you'd need twelve thousand dollars today just to have the same purchasing power. That's a big gap. Luna: Wow, that's a real-world example of how inflation eats away at your safety net. Lucas: And it's not just about the lump sum. You also need to think about your monthly contributions. If you're saving two hundred bucks a month, but your expenses are inflating at three percent, you might need to increase that contribution rate to stay ahead. Luna: So the takeaway is, your emergency fund is not a set-it-and-forget-it thing. You have to actively manage it. Lucas: Right. And one more tip, don't forget to shop around for the best high-yield savings account rates. The difference between a bank paying three percent and one paying four point five percent can add up. With the Fed funds rate at three point six three percent, some banks are still offering rates above that, so you might have to look for online banks or credit unions. Luna: And if you're worried about liquidity, make sure you have a checking account linked so you can transfer money quickly. Lucas: Exactly. So to sum it up, inflation is quietly eating your emergency fund, but you can fight back. Use I Bonds for a portion, consider a CD ladder for your second tier, and regularly review your balance to ensure it's keeping up with your real expenses. Luna: And maybe don't keep too much in that mattress, as we talked about in a previous episode. Lucas: Ha, right, that was a fun one. But yeah, it's all about being intentional. So next time you check your savings account, ask yourself, is this keeping pace with the cost of living? Luna: That's a good question to leave listeners with. Thanks for joining us on this episode of Inflation and Your Money with Fexingo. Lucas: And remember, if this episode made you think, and you want to support the show, you know the link, buy me a coffee dot com slash fexingo. But for now, we'll catch you next time.