Ask your parents what bread, a coffee or a month's rent cost when they were your age. The numbers will sound almost unreal. The bread did not get bigger. The money got smaller. That slow shrinking is called , and it affects every euro you keep, even in a drawer.
Before we start: what do you think?
You keep €1,000 in cash at home for 10 years. Prices rise by 3% every year. In today's money, about how much can that €1,000 buy at the end?
✗ Close, but 3% a year for 10 years is not a simple 30%, because inflation compounds.
✓ Right: €1,000 ÷ 1.03 to the power of 10 is about €744.09.
✗ That is roughly the effect of one year at 3%, not ten.
✗ The note still says €1,000, but each euro buys less, so the real value has fallen.
What inflation is
Inflation is the rise in prices over time. When prices rise, each euro buys a little less. What a sum of money can actually buy is called its .
A little inflation is normal. The European , for example, aims for inflation of 2% a year over the medium term. Many other central banks have similar targets. But inflation is not always close to the target. In October 2022, yearly inflation in the euro area reached 10.6%.
Inflation is also personal. The official figure is an average over a basket of goods. If food, rent and energy take most of your money and rise faster than average, your own inflation is higher.
Quick check
What does "purchasing power" mean?
How it adds up over the years
Inflation compounds, just like interest. Each year's rise is added on top of last year's higher prices.
Worked example: €1,000 and a €50 weekly shop, at 3% a year
To find the purchasing power of a sum after some years, divide it by 1.03 once for each year. To find a future price, multiply by 1.03 once for each year.
| Years | €1,000 buys what this many euros buy today | A €50 weekly shop will cost |
|---|---|---|
| 1 | about €970.87 | €51.50 |
| 5 | about €862.61 | about €57.96 |
| 10 | about €744.09 | about €67.20 |
| 20 | about €553.68 | about €90.31 |
At 3% a year, prices roughly double in about 23 to 24 years. The number of euros stays the same. What shrinks is what they can buy.
The rate matters. Over 10 years, €1,000 keeps about €820.35 of purchasing power at 2% inflation, about €744.09 at 3%, and only about €613.91 at 5%. One single year at 10% inflation takes €1,000 down to about €909.09.
Try a high rate for a few years, then a low rate for many years.
Quick check
At 3% inflation, roughly how long does it take for prices to double?
Nominal vs real returns
When a bank or a fund tells you what you earned, it usually shows the : the change in the number of euros. What matters for your life is the : the change in what those euros can buy, after inflation.
A quick estimate is: real return ≈ nominal return − inflation. The exact figure differs a little, but the estimate is close enough for everyday use.
| Your savings earn | Inflation | Real return (exact) | What it means |
|---|---|---|---|
| 0% (cash at home) | 3% | about −2.91% a year | you lose purchasing power every year |
| 2% | 3% | about −0.97% a year | more euros, but less purchasing power |
| 3% | 3% | 0% | you keep your purchasing power |
| 5% | 3% | about +1.94% a year | your purchasing power grows |
Take €10,000 for 10 years with 3% inflation. At 2% interest it becomes €12,189.94, which looks like a gain of more than €2,000. In today's money, it buys only what about €9,070.46 buys now. At 5% interest it becomes €16,288.95, worth about €12,120.51 in today's money.
So a that pays less than inflation is not a bad thing for your . Its job is safety, not growth. (See Your emergency fund.) But money you will not need for many years usually needs a plan that at least tries to beat inflation. That always involves some risk, and nothing guarantees it.
Quick check
Your savings earn 2% a year and inflation is 3%. Is your real return positive or negative?
What you can do about it
- Keep only what you need in cash at home. Cash earns nothing and loses purchasing power every year.
- Compare interest with inflation. When you look at a savings rate, ask: "Is it above or below inflation?"
- Update your budget every year. If rent and food rose by 5%, your has to change too. (See A budget that works.)
- Ask about your salary. A pay rise smaller than inflation is a real pay cut.
- Be careful with high-return offers. High inflation makes people nervous, and scammers know it. A promise to "protect your savings" with a fixed high return is a warning sign. (See Everyday money scams.)
For long-term money, growth over many years works through . Compound growth explains how.
Key takeaways
- Inflation is the rise in prices over time. Each euro buys a little less.
- It compounds: at 3% a year, €1,000 keeps about €744.09 of purchasing power after 10 years.
- Your personal inflation can differ from the official figure, depending on what you buy.
- Nominal return is the change in euros. Real return is the change in what they buy.
- Real return ≈ nominal return − inflation. Below inflation, your purchasing power falls.
Try this
Find a receipt, a bill or a price you remember from five years ago, and compare it with today's price. Divide the new price by the old one. Then look at the on your savings and write one sentence: "My savings earn %, and prices rise by about %, so my real return is about __%."