Are your savings beating inflation? Work out your real interest rate

I read a lot of ledgers, and the savings line in most of them tells a quiet story. The balance goes up every month, the interest arrives on time, and the owner feels, reasonably, that the money is safe. Then prices go up faster than the interest, and the money that looked safe buys a little less each year. Nothing on the statement shows it. The number only gets bigger.

So "are my savings beating inflation?" is a fair question, and this month it has an unusually clear answer to work with. The August US inflation figure came in at 3.4% a year. On 16 September, the Federal Reserve raised its target range by a quarter point to 3.75%–4.00%. In the UK, the ONS put August CPI at 3.1%, up from 2.9% in July. Savings rates are moving, inflation is moving, and the gap between them is the only number that tells you whether your cash is growing or shrinking.

This post shows how to work out that gap — the real interest rate — on each pot of money you hold, what tax does to it, and what moving the money would actually change, on real figures.

What the real interest rate is#

The rate a bank advertises is the nominal rate: how many more dollars or pounds you will have in a year. The real rate is how much more you will be able to buy with them. The difference is inflation.

The quick version is subtraction: a 4% savings rate with 3.4% inflation is roughly a 0.6% real return. The exact version divides instead:

real rate = (1 + savings rate) ÷ (1 + inflation) − 1

At these levels the two give almost the same answer, so subtraction is fine for a quick look. I use the exact formula below because the small differences add up when you are comparing pots.

A negative real rate does not mean you lose dollars. It means the dollars you get back buy less than the ones you put in. That is easy to ignore precisely because the balance still rises.

The rates you are actually comparing#

Three rates matter for most people, and they are far apart. On 24 September the best high-yield savings accounts were paying up to 4.50% APY, against an FDIC national average of 0.37% for ordinary savings. NerdWallet's tracker puts the average high-yield account at 3.66% in August, just above that month's 3.4% inflation. Against 3.4% inflation, those work out as:

• 0.37% (a typical ordinary savings or current account): about −2.93% real. Every $1,000 buys roughly $29 less after a year.
• 3.66% (an average high-yield account): about +0.25% real. Barely ahead.
• 4.50% (the top of the market this week): about +1.06% real. Ahead, before tax.

The headline rate on the best account is twelve times the national average, and that gap matters far more than any tweak to your budget percentages. But most people do not hold one pot at one rate. They hold several, and the answer depends on the mix.

A worked example: $12,000 across two accounts#

Here is one person's cash, the way it sits in a ledger: $4,000 in the savings account attached to her current account, at 0.37%, and $8,000 in a high-yield account at 3.66%. Inflation is 3.4%.

The blended rate is $307.60 ÷ $12,000 = 2.56%. Her real rate is 1.0256 ÷ 1.034 − 1 = −0.81%. In a year she will have $12,307.60, which buys what $11,902.90 buys today. She is about $97 poorer in real terms, while her statement shows her $307.60 richer.

Now two changes, one at a time.

Move the idle money, keep a buffer. She keeps $1,500 next to her current account for timing gaps between bills and payday, and moves the other $2,500 to the high-yield account. That makes $10,500 at 3.66% ($384.30) plus $1,500 at 0.37% ($5.55): $389.85 of interest, a blended 3.25%, and a real rate of −0.15%. The real loss shrinks from about $97 to about $18. Still negative, but only just.

Then shop the rate. If the $10,500 earns 4.50% instead of 3.66%, the interest is $472.50 + $5.55 = $478.05, a blended 3.98%, and a real rate of +0.56%. She is now about $68 ahead in real terms — a swing of roughly $165 a year from the starting point, for two transfers and an afternoon of reading terms.

Then there is tax#

Interest is usually taxable, and inflation is not deductible. That is the part most "beat inflation" articles skip.

Take a 22% tax rate on interest, purely as an illustration — yours depends on your income, your country and any allowance you have. The $478.05 becomes $372.88 after tax, a blended 3.11%, and her real rate goes back to −0.28%. Even the 4.50% account on its own is only 3.51% after that tax, which is +0.11% real.

The rate you need to beat inflation after tax is inflation ÷ (1 − tax rate). At 3.4% inflation and 22% tax, that is 3.4 ÷ 0.78 = 4.36%. Very few instant-access accounts clear that line with much to spare this month. Tax-free wrappers change the arithmetic — in the UK, a cash ISA or the Personal Savings Allowance can take the tax line to zero for many savers — so check which one applies to you before you conclude anything.

Your inflation is not the headline number#

The 3.4% is an average across a national basket of goods. Your basket is not the average. The same August report showed gasoline prices up 27.4% on a year earlier; someone who drives a lot has had a much worse year than 3.4%, and someone who does not has had a better one.

Your ledger can tell you which. Compare what you spent in each category over the last three months with the same three months a year ago, category by category, and look at the ones where you bought roughly the same things: groceries, energy, fuel, insurance. If your essentials rose 5%, your savings have to earn more than 5% to keep pace with the life you live, and the emergency fund you sized from last year's essentials may need resizing too.

What to do with the answer#

Not every pot has to beat inflation, and chasing a real return with money that has a job is a mistake. Three rules keep this straight:

1. The emergency fund's job is to be there. Instant access matters more than the last half point. Put it in the best instant-access account you can find, and stop there. Locking it into a fixed-term account for 0.3% more defeats the purpose.
2. Sinking funds are spent within a year. Money set aside for the insurance renewal or December, as in the sinking funds post, barely has time to lose value. Keep it accessible and earning something; do not agonise over it.
3. Debt comes first. If you carry a card balance, its rate is several times anything a savings account pays. Paying it down is a guaranteed return at that rate, and the balance transfer arithmetic shows how to cut it further. Beating inflation on savings while paying interest on a card is running on the spot.

Money beyond those jobs — cash you will not need for five years or more — is where "beating inflation" becomes a real goal, and where savings accounts are not the only tool. That is a longer conversation, and one for a qualified adviser who can see your whole situation.

This is educational arithmetic, not advice about your money. Rates change weekly, and high advertised rates often come with conditions, caps or introductory bonuses that expire; read the terms before you move anything.

What to ask an advisor about it#

Inside Azno your accounts, their balances and your spending are already in one ledger, so the arithmetic above is three questions rather than a spreadsheet:

• "What is the blended interest rate on all my cash, and what is it in real terms at 3.4% inflation?" — each account's balance and rate, the weighted average, and the real figure worked out with the formula above.
• "How much have my essentials gone up compared with the same three months last year, by category?" — your personal inflation, read from your own entries rather than the national basket.
• "If I keep $1,500 in my current account and move the rest to an account paying 4.50%, what changes over a year?" — this comes back as a proposal with the before and after worked out; nothing moves, and nothing is written, until you approve it.

If your accounts are not in one place yet, create an account and enter your balances and rates, even roughly. Knowing your real rate is the difference between feeling safe and knowing whether you are.