Are You Smart Enough To Beat Inflation? Solve These Money Puzzles To Find Out

“Inflation” is a word any money-conscious adult hears or reads almost daily, but that doesn’t mean everyone totally understands how it can impact their finances. Truly comprehending the complexities of inflation, and how it can sway your financial stability, is a requirement for any financially responsible adult.

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With that in mind, do you understand inflation? Further, are you smart enough to beat it? Take this GOBankingRates quiz to find out.Olemedia / Getty Images/iStockphoto

What Is Inflation?

The first step to beating inflation is understanding it. True or false: Inflation is the increase in prices of goods and services within an economy over a certain period of time, often caused by a destabilization between supply and demand.

A) True

B) False

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Answer: What Is Inflation?

If you answered (A) True, you’re 100% correct. Inflation is, essentially, a higher cost of living. Goods and services increase in price due to such factors as crises (like the COVID-19 pandemic or a housing crisis), general supply chain problems, consumer demand and more.

Discover More: 8 Smart Ways Frugal People Are Living Like There’s Already a RecessionFerenc Cegledi / iStock.com

Understanding Inflation Rates

Assume your weekly groceries cost $100 in 2024. Further assume that in 2025, the exact shame shopping list now costs you $108.

A) What is the inflation rate between 2024 and 2025 shopping trips?

B) If your salary went from $100,000 to $105,000 over the course of the same year, did your real income increase or decrease, and by how much?SolStock / iStock.com

The Answers: Understanding Inflation Rates

A) The inflation rate that impacted your groceries is 8%. Didn’t come up with the same answer? Here’s how you calculate it: Subtract the previous price from the current one ($108 – $100 = $8), divide that sum by 100 ($8/100 = 0.08) and then multiply the final result by 100 (0.08 x 100 =  8%).

Your groceries have increased by 8% due to inflation.

B) Regarding a real income change, similarly subtract your previous salary from the current one ($105,000 – $100,000 =  $5,000), divide that sum by 100,000 (5,000/100,000 = 0.5, or 5%) and subtract the inflation rate from that sum (5% – 8% = -3%).

Your real income change is -3%, meaning it fell by 3%.©GOBankingRates

Investing vs. Inflation

Imagine that you invest $25,000 in a savings account that yields 5% annually, with inflation averaging 6%.

Story Continues

After 10 years, are you richer or poorer in real terms? By how much?Mongkol Onnuan / Getty Images/iStockphoto

The Answer: Investing Versus Inflation

Adjusting for inflation after one decade, you’d actually be poorer by $2,252.18, with an amount of $22,747.82.

How?

First, calculate the nominal value after 10 years using the compound interest formula [Future Value (FV)=P(1+r) t ]. P = 25,000. r = .05 (annual interest). t = 10 years.

Using that formula [25,000(1+.05)10 = 25,000 x 1.6289], you’re left with a nominal value of $40,722.50 after 10 years.

Adjusting for inflation (by dividing that nominal value of $40,722.50 by a 6% inflation rate, or 1.7908), you’re left with a total of $22,747.82.

That’s $2,252.18 less than you started with.IcemanJ / Getty Images/iStockphoto

Wages and Inflation

If you received a 3% raise this year, but the inflation rate currently rests at 6%, would your real income increase or decrease, and by what percentage?108photo / Shutterstock.com

Answer: Wages and Inflation

In this scenario, your real income rate would diminish by 3%.

Why?

To determine your real income change, you only have to subtract the inflation rate from the nominal raise, or 3% – 6% = -3%. Despite the fact that you’d receive a 3% pay hike, inflation has raised prices around you by 6%. Thus, despite your raise, you’re actually able to afford less than you did before.primeimages / iStock.com

Credit Debt and Inflation

A final true or false: While racking up debt is never the optimum solution to a problem, in times of high inflation, it’s better to spend using credit than cash.

A) True

B) FalseKiwis / iStock.com

Answer: Debt and Inflation

Sure, paying down debt might seem like an unusual method to guard against inflation, but the answer is indeed (B) False. Why? High-interest debt — such as loans and credit card balances — becomes pricier as inflation gets higher.

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This article originally appeared on GOBankingRates.com: Are You Smart Enough To Beat Inflation? Solve These Money Puzzles To Find Out

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