I’ve never really given inflation much thought. I kinda sorta know what it means…(Over time, the price of goods and services will rise… and thus the same AMOUNT of money will buy less of a given product or service. This a super, duper over-simplification. To get your “NERD ON”, check out this article about Inflation. Then, when your mind has been blown, come back and finish the rest of my post…)
So, you are back. Confused? Me too. But, I see the effects of inflation every day. Have you noticed the price of a 20 ounce Coke at your local store? They used to cost 99 cents, then 1.09, then 1.19, and now 1.29. That, my friend is inflation. Inflation, at whatever rate, is a reality. Check out this calculator from Measuring Worth. It calculates the relative purchasing power of a given amount for any period from 1790-2005. IT WILL AMAZE YOU. It calculates inflation using 5 different methods. As an example, to buy what 100 dollars would purchase for you in 1975, you would need (depending on the method of calculation) 362, 296, 361, 553, or 760 dollars today. That’s right. The calculator is amazing. For fun, put in 100 dollars in 1800, and see what you get. Check it out: At the low end, it would take 1600 dollars in today’s money. At the high end? 2,500,000 dollars! The calculator is very, very, very interesting, and I think you will enjoy playing with the number and reading the information.
BUT, how does this information affect US. What can we do with the following fact: Over time, the price of all products goes up, and the value of a given amount of currency goes down. Well, we can do the following:
Look for HIGHER rates of return on savings and investments: Let’s use our 1975 example. In order to BREAK EVEN, to maintain the purchasing power of your 100 dollars, you would have needed to make around 5% per year on your money. (The average of the calculated results for how much purchasing power you would need to equal 100 dollars is 466 dollars. So, in order to have the same purchasing power, 30 years later, your 100 dollars would have to grow to 466 dollars. At 5 percent, your money would have grown to about 450 dollars, and you would have come close to breaking even.) Does this scare you a little bit? Think about it. Growing at 5%, your money is barely (if even) staying equal with inflation. (Most online savings calculators figure inflation from between 3 and 6 percent.) Bottom Line: To keep up with inflation, your savings must grow at at least 5%. To MAKE money, your money needs to grow at a rate GREATER than 5%. So, those awesome 5 and 6 percent CD rates? Umm… not so awesome.
What to do, what to do? Well, you must find investment vehicles that out-pace inflation. In other words, those that have HIGHER rates of return than 5%. Quick chart:
100 dollars for 30 years at 5% = approx. 450
100 dollars for 30 years at 6% = approx. 575
100 dollars for 30 years at 7% = approx. 760
100 dollars for 30 years at 8% = approx. 1000
100 dollars for 30 years at 9% = approx. 1325
100 dollars for 30 years at 10% = approx. 1744
100 dollars for 30 years at 11% = approx. 2300
100 dollars for 30 years at 12% = approx. 3000
Check that out. The difference between 6% and 12% over 30 years is almost SIX TIMES the purchasing power. SIX TIMES!!!
Remember, the above DOES not include a discussion of the effects of taxation on your money. But, as you can see, if you can invest the money an let it grow TAX FREE (In an account such as a ROTH IRA or a ROTH 401K or an ESA) then you do not have to worry about taxes on future growth.
One more thing. Time. Not only is the interest RATE important for “defeating” inflation, but the amount of TIME that your money is allowed to grow is VITALLY important. The longer your money has to grow, the more it will grow, and the more purchasing power it will have. So, if you are 20, start saving and investing. If you are 30, start saving and investing. If you are 40, start saving and investing. If you are 50, start saving and investing…..!!!!
Bottom line: Get out of debt, start saving some money, and begin to invest! Inflation is a REALITY, whether we understand it or not. Don’t wait.