Inflation

Fees eat your returns from the cost side. There’s another force working the other side of the equation: the dollars you earn are worth less every year. You’ve watched it happen your entire life. A cup of coffee cost a dollar in 1995. It costs three or four dollars now. What you may not have thought about is what that means for the money sitting in your savings account.

That money is shrinking. Not the number on the screen. The number stays the same, or even grows a little with interest. But what those dollars can buy gets smaller every year, quietly, automatically, whether you’re paying attention or not. Your savings account isn’t protecting your money. It’s giving you a front-row seat to watch it lose value.

Fees were a cost you could control by choosing cheap index funds. Inflation is a cost you can’t avoid. But you can outrun it. You already own the tool that does that.

What Inflation Actually Is

Prices go up. That’s it.

Not a crisis. Not a conspiracy. A constant. The Federal Reserve explicitly targets 2% annual inflation as a sign of a healthy economy. They want prices to rise slowly, steadily, predictably.

Purchasing power is the term for what your dollars can actually buy. When inflation runs at 3%, your dollar’s purchasing power drops by 3%. The dollar bill in your wallet looks the same. It spends the same. It just buys less. A hundred dollars today and a hundred dollars ten years from now are not the same amount of money, even though the number is identical.

How much purchasing power have you already lost? More than you think.

The Slow Leak

In 1995, a gallon of gas cost $1.15. Today it’s around $3.50. A movie ticket was $4.35. Now it’s $11.

None of those price increases happened overnight. You didn’t wake up one morning to find gas had tripled. It crept. A few cents a year. So gradual you barely noticed, until you looked back across three decades and realized your money covers half of what it used to.

Since 1926, inflation in the United States has averaged about 3% per year. Some years higher (14% in 1947, 13% in 1980). Some years close to zero. But averaged across nearly a century of data, prices roughly double every 24 years.

Put it in today’s terms: $100 now buys what $48 bought in 1994. Your dollars didn’t go anywhere. They just became worth less.

The 3% average sounds small. So did the 1% fee in Fees and Expenses. Small percentages are the most dangerous numbers in personal finance because they compound silently over decades.

What Inflation Does to Your Savings

Cash in a savings account feels safe. You can see the balance. It doesn’t go down. The bank might even pay you a little interest. This feeling of safety is the problem.

A high-yield savings account pays around 2% right now. If inflation runs at 3%, your money loses 1% of its purchasing power every year. The balance grows. What it buys shrinks. You’re falling behind and the account statement makes it look like you’re getting ahead.

Put $10,000 in a savings account and $10,000 in a stock index fund. The savings account earns 2%. The index fund averages 10% nominal (that is, before adjusting for inflation), roughly 7% after. Inflation runs at 3%.

Years	Savings Account Balance	Savings Purchasing Power	Index Fund Balance	Index Fund Purchasing Power
0	$10,000	$10,000	$10,000	$10,000
10	$12,190	$9,060	$25,940	$19,670
20	$14,860	$8,200	$67,280	$38,700
30	$18,110	$7,430	$174,490	$76,120

Read the savings account column. After 30 years, the balance grew to $18,110. That looks like progress. But in today’s dollars, that $18,110 only buys what $7,430 would buy today. You lost more than a quarter of your money’s real value. The account balance went up while your wealth went down.

Now read the index fund column. $10,000 became $174,490, with a purchasing power of $76,120 in today’s dollars. Not just preserved. Multiplied. Seven times your original purchasing power versus three-quarters of it.

The savings account isn’t safe. It’s a slow, guaranteed loss. The index fund feels riskier because the balance bounces around. But over 30 years, the “risky” option made you seven times wealthier in real terms, and the “safe” option made you poorer.

Most people get this backwards. They think the risk is in the stock market. The real risk is in the savings account: if “safe” means your money will still buy groceries in 30 years, cash is one of the worst places to put it. Stocks are volatile. Cash is certain. Cash is certain to lose.

Why Stocks Beat Inflation

Companies raise prices.

When gas goes from $1.15 to $3.50, the oil company’s revenue goes up. When a movie ticket goes from $4.35 to $11, the theater chain collects more per seat. Inflation flows through the economy, and companies are on the receiving end. Their costs go up too, but over time, revenues and earnings rise roughly in line with the overall price level. Often faster.

This is the mechanism. It’s not abstract. When you own a total stock market index fund, you own a piece of every public company in America. Those companies sell goods and services at prices that rise with inflation. Their earnings grow. Their stock prices follow. The index goes up not just because of economic growth, but because the dollars it’s priced in are worth less.

The U.S. stock market has returned roughly 10% per year since 1926. Inflation has averaged about 3%. That leaves roughly 7% in real, after-inflation returns. Seven percent real means your purchasing power doubles about every 10 years.

This is why you’re investing, not just saving. A savings account tries to keep pace with inflation and fails. Stocks don’t try to keep pace. They blow past it. Owning the entire market through an index fund captures the full return of American business: real economic growth plus inflation flowing through corporate earnings. Both work in your favor.

You don’t need to pick the right inflation-beating stocks. Your total market index fund owns all of them, and market-cap weighting automatically gives more weight to the companies that grow. You don’t need to time your purchases around inflation reports. Dollar cost averaging on a fixed schedule handles that whether inflation is running at 2% or 5%.

Where This Breaks

In 2022, inflation hit 9.1% and stocks dropped 19%. The thing that’s supposed to beat inflation lost money while prices surged. Both sides of the equation went wrong at the same time.

This happens. Short-term, stocks can fail badly as an inflation hedge. In the 1970s, inflation ran above 6% for a decade while stocks went sideways. Investors who needed their money during those years got hurt.

But zoom out. From 1970 to 2000, U.S. stocks returned about 12% annually, crushing inflation over the full period despite a miserable decade in the middle. The 1970s stagflation was brutal while it lasted. The investors who kept buying through it on a fixed schedule owned shares purchased at depressed prices that compounded for the next twenty years. The investors who panicked and moved to cash locked in losses and then watched inflation eat whatever was left.

There are investments designed specifically to fight inflation: Treasury Inflation-Protected Securities (TIPS) and I Bonds, both sold by the U.S. government, adjust their value with rising prices. They’re real tools, but they protect against inflation without beating it by much. A portfolio of stocks has historically grown at 7% above inflation. Your index fund already handles the job and builds wealth on top of it.

None of this means you should empty your savings account. An emergency fund covering three to six months of expenses belongs in a savings account despite inflation eating at it. That’s the cost of having money available when you need it fast. The rest, the money you’re investing for goals 10 or more years away, belongs in your index fund where it can outrun inflation instead of losing to it.

What’s Next

You know what to invest in, how to invest, how to split your money, and what’s working against you. Time to build the actual portfolio. The Three-Fund Portfolio turns three index funds into a concrete plan: which specific funds to buy, in what proportions, and where to hold them.