What inflation is and how it eats your savings without you noticing

What you'll have at the end

One figure for your own household's inflation, worked out from what you buy, and a rule that splits your savings between what stays cash and what gets converted.

Step one: understand the mechanism in two sentences

Prices in general rise by some percentage each year. Every unit of money you hold buys that much less at the end of the year than it did at the start. If inflation is 5 percent, the 40,000 AED in the drawer buys, a year on, what 38,000 used to. Nobody took it, and it's gone.

Step two: measure your inflation, not the newspaper's

The official figure is a general basket that doesn't look like yours. If you've been logging purchases for a year, you have your own number: take ten things you buy every month, oil, rice, milk, petrol, bread, chicken, and compare each one's price today with its price in the same month last year. The average is your household's inflation. For an Egyptian household in a hard year it comes out above 30 percent; for a Gulf household in an ordinary one, between 3 and 5. Those two numbers mean two completely different decisions.

Anyone not logging starts today; a year from now they'll have the figure. It's one of the most useful things that comes out of expense tracking, and nobody mentions it.

Step three: split the cash into three

What you'll need within three months stays cash, because its liquidity matters more than its value: the daily figure, the month's expenses, stages one and two of the emergency fund. What you'll need within a year, the near seasons, also stays cash if your inflation is under 5 percent, and becomes small gold if it's above. And what you won't need for a year all becomes something that holds value or earns: gold, a stronger currency, a share in something, land.

Whoever keeps a million in a drawer in a country with 25 percent inflation pays 250,000 a year for a false sense of safety. Whoever puts everything into land and suddenly needs a fridge sells at a loss. The first third protects you from the second.

Step four: read land and gold correctly

A plot on the edge of a city doubles or triples in a few years when the building reaches it, and that's an example of a real asset outrunning inflation. But it doesn't sell in a day, and it's bought with money you won't need for five years. Gold sells in a day and holds value and earns nothing. Each has a lesson coming; what matters now is understanding that a "real thing" is anything whose price rises when prices rise, and cash alone is what doesn't.

Step five: set the risk by your age

Someone with thirty working years ahead can afford to lose part of a volatile asset, because they'll rebuild it. Someone ten years from retirement holding a lifetime's savings can't, and stays in the calm things: gold, a home to live in, a share in a large stable company. The rule: the nearer the day you'll need the money, the less of it goes into anything that swings.

Where most people trip

At the two extremes: leaving everything as cash out of fear, or turning everything into land out of greed. The first quietly loses a share every year; the second sells the land at half price in the first crisis. The cash third is what protects the other two.

Tonight's exercise

Pick ten things you buy every month. Write each one's price today, and its price a year ago from memory or your log. Work out the average. Then write the total you hold in cash and multiply by your inflation: that's what you lose next year if you do nothing.