Clouds float past us, light and fluffy, every day. But are they actually light? The average cumulus cloud you see on a sunny day actually weighs about 1.1 million pounds! We know it is possible, but it still seems to defy logic.
Inflation also seems to defy logic. We talk with clients about inflation all the time, yet it remains a difficult idea to keep in mind when we plan for the future.
Inflation is an economic phenomenon where prices increase over time. Phrased differently, money slowly buys us less over time. There are a few reasons why this happens, which we won’t cover today, but the Federal Reserve targets 2% inflation per year. Depending on the time period, the US averages about 3-3.5% a year. In the 70s, inflation averaged over 7% a year!
What does this mean?
- Money sitting in a bank account earning .1% a year is, in real terms, losing value.
- Assuming a 3.1% inflation rate, it takes about 22 years for a dollar to lose half its value.
- Something that cost $100 in 1914, all else equal, would cost $2,608.88 today!
Look no further than the gas pump: in 1950 gas was a whopping 18 cents per gallon.
Of course, some industries inflate at much greater rates. According to the Bureau of Labor Statistics, college tuition averages about 7.4% a year, and healthcare costs average about 5.28%. That means college costs are doubling every ten years!
What does this mean for you?
Considering inflation within one’s financial plan is critical to life’s big moments! It helps keep Future You financially secure twenty years after you stop working and start spoiling the grandkids. Factoring inflation in keeps weddings affordable, vacations within reach, and the elderly with their dignity.
Inflation also changes how we think about risk. Retirees concerned about losing money often become more conservative investors. But investing too conservatively can lower our investment returns and make inflation much more painful.
A last thing that defies reality: the Greenland shark’s lifespan is reportedly 500 years. Thank goodness I am not a Greenland shark parent with kids aspiring to be shark dentists. Hundreds of years of inflation would mean really expensive college.