Inflation is a silent enemy: it erodes the value of money day after day, often without our noticing. It affects everyone, from the small saver to the seasoned investor. Understanding how it works is the first step towards protecting your wealth.
What inflation is: the shopping trolley that empties
Inflation is the generalised and persistent rise in the prices of goods and services in an economy.
Imagine going to the supermarket: if a year ago €50 filled your trolley, today the same products might cost you €55. The central point is that your €50 buys less than before: it has lost purchasing power.
This loss — silent, gradual and cumulative — is inflation's real threat to savings and to living standards.
How it is measured: the Consumer Price Index
To quantify inflation, economists use indices such as the Consumer Price Index (CPI), calculated in Italy by ISTAT. The index measures the average change over time in the prices of a representative "basket" of goods and services purchased by Italian households. The basket is updated periodically to reflect changes in spending habits.
Take a purely illustrative example: if ISTAT recorded annual inflation of 2.3%, it would mean that on average the prices in the basket had risen by 2.3% over twelve months. It is a snapshot of the speed at which money is losing value.
A useful caveat: official inflation is an average. The inflation you feel in your own wallet depends on how you spend. Someone who devotes a high share of their income to energy and food may experience personal inflation well above the ISTAT figure.
The main causes
- Rising demand. When demand for goods and services exceeds available supply, prices tend to rise.
- Rising production costs. If the costs of raw materials, energy, labour or transport increase, businesses tend to pass them on to final prices.
- Monetary policy. Central banks (the ECB, the Fed) influence inflation through interest rates and the quantity of money in circulation. Monetary conditions that are too accommodative for too long can fuel inflation.
- Expectations. If businesses and workers expect higher prices, they adjust their price lists and wage demands in advance. Expectations tend to be self-fulfilling, which is why central banks monitor them so closely.
Why inflation is a problem for your savings
Suppose you have €10,000 sitting in a current account. With inflation of 2.5% a year:
| Horizon | Remaining purchasing power (at today's prices) |
|---|---|
| 1 year | ~€9,756 |
| 5 years | ~€8,839 |
| 10 years | ~€7,812 |
| 20 years | ~€6,103 |
In nominal terms you still have €10,000. In real terms, after ten years you have lost almost €2,200. It is like an annual withdrawal that nobody tells you about.
It is worth adding that the ECB's price stability objective is 2% over the medium term: the 2.5% in the example is therefore already slightly above target, not the stated objective.
How to defend yourself
The defence is not to hide your money, but to put it to work. Some strategies widely used by investors:
1. Invest, don't just save
Setting money aside is healthy, but to beat inflation savings need to generate a positive real return, that is one above inflation — and it must be calculated net of taxes and costs, not gross. A current account is safe in nominal terms, but it rarely offsets the erosion of purchasing power.
2. Choose assets that have historically offered protection
- Equities. Companies with pricing power can pass rising costs on to customers and defend their margins, and this tends to be reflected in the value of their shares. It is, however, a long-term protection: in the short run, as in 2022, inflation spikes often coincide with falling stock markets.
- Property. Real estate tends to appreciate with inflation and rents can be adjusted. Consider the flip side too: poor liquidity, maintenance costs, taxes and sensitivity to interest rates.
- Inflation-linked bonds. Government bonds such as Italy's BTP Italia (linked to Italian inflation) or US TIPS revalue their principal and coupons in line with price movements, with the aim of preserving the real return.
- Handle with care: long-dated fixed-rate bonds. They are the most exposed asset: inflation erodes both coupons and the principal at maturity, and the rate rises that usually accompany it depress their market price.
3. Harness compound interest
As we have explored in previous articles, compound interest allows capital to grow by generating returns on returns already earned. Putting capital to work over time at a rate above inflation is the most effective way to increase purchasing power over the long run.
4. Diversify your portfolio
Inflation does not hit all asset classes in the same way, nor at the same time. That is precisely why diversification — across equities, bonds, commodities, real estate and geographies — is the soundest defence: it reduces dependence on a single macroeconomic scenario and softens the impact of whatever you did not foresee.
Conclusion
Inflation is an implicit tax on savings that, if ignored, erodes wealth silently but substantially. The good news is that it is a manageable risk: understanding its mechanisms, weighing the available options and building a strategy consistent with your objectives allows you not only to protect yourself, but to grow your capital in real terms. The first step, as always, is financial education.
Disclaimer: the information in this article is purely educational and does not constitute financial advice. Every investment decision should be made after careful assessment of your own circumstances and with the support of a qualified professional.