Inflation

💰 Personal Finance · 3 min read · Last reviewed 2026-10-02 · By the AlfaFinances editorial team

Inflation is the general rise in prices over time, which means the same amount of money buys a little less each year. It's why cash sitting idle loses real purchasing power over time, even though the number on the account never goes down, this is a core reason many people invest rather than just save, since investment returns can outpace inflation while a low-interest savings account often doesn't.

A worked example

If inflation runs at 3% a year, something costing $100 today will typically cost about $103 next year, and roughly $134 in ten years. $10,000 sitting in cash earning 0.5% interest while inflation runs at 3% is effectively losing about 2.5% of its real purchasing power every year, even though the account balance itself is technically growing slightly.

Key takeaways

Inflation erodes the purchasing power of cash over time, even if the balance stays the same or grows slightly.
Investment returns that outpace inflation grow real wealth; returns that don't merely keep pace are treading water.
Inflation is a key reason to consider investing excess cash rather than just saving it long-term.

Common mistakes

Keeping large amounts of money in cash for many years, not accounting for inflation eroding its value.
Not factoring inflation into long-term financial goals like retirement planning.
Assuming a nominal (stated) interest rate is the whole story, without checking it against inflation.

Test yourself

1. What is inflation?

A drop in prices over time
A general rise in prices over time
A type of interest rate
A tax on savings

Answer: A general rise in prices over time. Inflation is the general increase in prices over time, reducing what a fixed amount of money can buy.

2. What happens to cash sitting idle during a period of inflation?

It automatically grows to match inflation
It loses real purchasing power over time
Nothing changes at all
It becomes illegal to hold

Answer: It loses real purchasing power over time. Even if the account balance doesn't shrink, inflation means that money buys progressively less over time.

3. Why is inflation often cited as a reason to invest rather than only save?

Investing eliminates inflation entirely
Investment returns can outpace inflation, growing real purchasing power, unlike many low-interest savings accounts
Saving is always better than investing
Inflation only affects investors

Answer: Investment returns can outpace inflation, growing real purchasing power, unlike many low-interest savings accounts. Investments with returns above the inflation rate can grow real wealth, while cash earning less than inflation slowly loses value.

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Sources and further reading

Educational information only, not financial advice. AlfaFinances does not execute trades, hold your money or recommend that you buy or sell any security. Prices and company data come from public sources and may be delayed or inaccurate. Past performance does not indicate future results, and investing involves risk, including loss of principal. See our editorial policy and privacy policy. Last updated: 2026-10-02.