Imagine it’s 1920 and you’ve been given $20 to buy groceries. With that same $20, you’d be able to buy only $1.04 worth of groceries today.
It used to cost just 25 cents to stamp a letter and mail it to your pen-pal in 1988. Today, it’ll cost you 55 cents. If you’re curious, here’s a fun historical chart of the price of stamps, dating back to 1863 when a stamp was just 3 cents.
Since 1958, inflation has historically averaged 2.5% to 3.7%.
To put that into perspective, let’s assume that the average inflation will be about the average 2.5%moving forward and your current income is $50,000 today.
In the year 2030 (ten years from now), your income is really worth $39,060. In other words, to earn the same $50,000 as you are today ten years from now, you will actually need to earn $64,004.
In the year 2040 (twenty years from now), your $50,000 today is worth $30,513. By 2040, your income needs to be $81,931 if you want to keep up with the cost of living.
Inflation is an increase in the cost of goods and services over time, resulting in a decrease of your purchasing power. In other words, the dollar you have in your pocket today will be worth less tomorrow.
Hence, we encourage clients to find jobs that keep pace with inflation, ask for a raise, and/or get bonuses. At our financial workshops, we always encourage attendees to ask for a raise or move to a different job that can pay more. It’s not so easy to do, but for every year you delay getting a raise, you are losing 2.5% of your income.
Moreover, not only does your income need to keep pace with inflation, but so do the assets you accumulate over your lifetime.
Think your cash in that savings account is risk free? If your assets are all held in cash, inflation is working against you every day, slowly chipping away at its value.
Inflation is that “invisible” risk that most don’t think about. That is the risk of NOT investing.
It’s important to invest a portion – not all – of your money for the long-term with the goal of getting a return that’s at least at pace with inflation or better. Your total portfolio should be diverse, spread over different asset classes and types of investments. That may include real estate, bonds, cash, cash equivalents such as CDs, stocks, commodities, collectibles, and anything else that has the potential to increase in value or provide a return in the form of dividends and interest.
Yes, investing has its own set of risks. But so does not asking for higher pay and keeping all your money in cash.
When it comes to practical applications for understanding inflation, your annual pay and expenses are one of the most important to consider. Assuming the economy continues to grow, we will continue to see the effects of inflation year after year. Inflation means an increase (however modest) in the cost of the goods and services you pay for. So if your income is not seeing a modest increase year after year to at least keep pace with inflation, you either need to consider a job change or take that into account when reevaluating your monthly budget and the types of investments you own.
The most important thing is to be aware of inflation and how it affects your financial bottom line long term.
THE BOTTOM LINE:
Inflation is unavoidable. It’s the basics of economics that you have to take into serious consideration, especially when it comes to your pay and personal investments, but having awareness of what it means and how it affects your financial bottom line is the key to making sure it doesn’t sneak up on you over time.