Lesson 2 of 7 · 2 min · Money

The quiet shrink

Your money can lose value without ever losing a dollar.

Pencil drawing of a green $100 bill with an arrow down to a faded box worth $74.
Open the drawn lesson

  1. Inflation means prices rise over time. The same $100 buys a little less each year, even though it still says $100.

  2. The US Federal Reserve and the European Central Bank both aim for about 2% inflation a year. It is often higher. Take 3% as an example.

  3. At 3% a year, $100 buys after ten years what about $74 buys today. After 24 years, about half. The rule of 72 works here too: 72 divided by 3 is 24.

  4. So what counts is the real return: what you earn minus inflation. Earn 7% while prices rise 3%, and your buying power grows about 4%.

  5. Cash in a drawer earns nothing, so at 3% inflation it quietly shrinks by about a quarter every ten years. Safe from falling prices is not safe from rising ones.

Quick question

Your savings account pays 1% a year. Prices rise 3% a year. What happens to your buying power?

  • It grows by 1%
  • It shrinks by about 2%
  • It stays the same
Show the answer

It shrinks by about 2%

The real return is about 1% minus 3%. Your balance goes up, but what it can buy goes down by roughly 2% a year.

Keep this one

Count in what money buys.

Where this comes from

The Fed and the ECB both target 2% inflation. The 3% rate and the 7% return are round examples. Buying power after n years: 100 ÷ 1.03^n.