Why Inflation Should Be A Core Focus In Your Investment Plan
My intention of this post is to convince you of investing in a manner that at the minimum will maintain the purchasing power of your investments to keep up with inflation. It is a crucial part in your investment program.
Have you happened across a picture that illustrates the prices for certain goods from the 1950s or 1960s? If so, you instantly recognize that pricing has dramatically changed. You might look upon the list of prices regarding the dollars you make today. How you could purchase 10 houses for the price of 1 house. A dollar would extend further in those times. But, the value of a dollar in 1960 differs considerably from a dollar in today’s time.
Let us begin with the cost of living in 1962.
As you can observe, the prices are drastically different from today. But, lets have a look into it a little further.
The average annual inflation rate per year since 1962 has been 3.84%. That means out of a $100 dollars, $3.84 of purchasing power is removed each year.
What is purchasing power? Purchasing power is the acquisition of goods and services with a unit of currency. For example, you could have purchased 6 apples for $1 in 1955, but now you can only buy 2 apples for that same dollar. Now we understand purchasing power, let’s go back to the list of prices from 1962.
If you take the prices from this image and bring them into current dollars with inflation included, you have:
New House- $103,529
Average Income- $45,883 per year
New Car- $24,121
Average Rent- $907 per month
Tuition to Harvard- $12,539 per year
Movie Ticket- $8.25 each
Gasoline- $2.23 per gallon
USPS Stamp- $0.33 each
Sugar- $7.34 for 10 pounds
Milk- $8.58 per gallon
Ground Coffee- $7.01 per pound
Bacon- $5.69 per pound
Eggs- $2.64 per dozen
Hamburger- $3.30 per pound
Bread- $1.73 per loaf
The new numbers illustrate how comparable the prices are today to that of 1962. The purchasing power of $1 in 1962 has the same purchasing power as $8.25 in 2018. Some prices are cheaper when adjusted for inflation. Even though the prices are comparable if not the same, to those of 1962, the moral of the story is that inflation is a real cost.
Inflation Concern Over The Short Term
Now, that we have established inflation as a legitimate cost to the tune of 3% a year. What is important over the short term? Even though inflation is a cost. Over the short term, it can be managed by good financial planning.
A disciplined approach to sound financial planning suggests that you try to keep somewhere between 3-12 months of reserves in liquid cash depending on your particular situation in an easily accessible bank account. Yes, that cash is losing its purchase powering each year, but the value of having that cash immediately available is worth the cost of inflation in most cases.
Liquid cash, sometimes known as dry powder, can also be the seed money for a future investment. Cash in a standard bank account or CD will not receive the same fluctuations you would have in the investment market. If you want to learn more about those fluctuations, you can read further about volatility here.
Inflation Concern Over The Long Term
Inflation over the long term is a real risk and should be recognized in any stable investment plan. Let’s go back again to the 1962 prices listed in the picture above. Prices are 726.3% higher in 2018 than in 1962. You read that correctly, 726.3%. That percentage shows the power of compounding.
Your investment plan has to account over the long term for inflation so you can keep purchasing power when you go to spend those investment dollars on your goal or retirement.
When we are developing an investment plan for any future goal, it's easy to only look at the upside. How much is this investment “expected” to increase over the next 5, 10, 30, or 50 years given the overall horizon of the goal? It is good to have a focus on the rate of return of your investment, but, I plead with you to make sure you are considering inflation into your plan and that you are keeping your purchasing power along the way.
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