Supposeyou Reheadingofftocollegenextyearsomewherecold,Andyouwanttopurchaseanorthfaceparkafor

Investing

7.1InvestmentBasics

Activity

ReadtheArticleattachedattheendofthisworksheetbeforecompletingthisactivity.

UnderstandingInflation

Fromthepreviousresources,you’veseenthatsavingmoneyinabankaccountthatearnslessininterest(ex:0.75%) thantheeconomyexperiencesinflation(avg:3%)leavesyouwithlessspendingpowerinthefuture.Ifyousave$500inasavingsaccountnow,you’llbeabletobuyLESSwithitin2025thanyoucouldtoday.That’swhatmakesINVESTINGanimportantpartofyourlong-termfinancialhealth.Let’sexploreinflationalittlefurtherusingthisInflationCalculator fromtheBureauofLaborStatistics:

Supposeyou’reheadingofftocollegenextyearsomewherecold,andyouwanttopurchaseaNorthFaceparkafor

$350.

1.Fromeachpaycheckofyourafterschooljob,you’reabletosave$45towardthecoat.Yougetpaidtwiceamonth.HowmanymonthswillittakeyoutosaveenoughmoneytobuyyourNorthFacejacket?

2.Usingthisstrategy,howwillinflationimpactyourabilitytobuythejacket?

3.You’rethinking$350isalotofmoneyforahighschoolstudent,andyouunderstandthat,duetoinflation,thatsamejacketwouldhavecostlessthan$350inthepast.Usethecalculatortodeterminehowmuchthesamejacket,haditbeenavailable,wouldhavecosttheyearyouwereborn.

4.Howmuchcheaperwasthecoattheyearyouwereborn?

5.Youtakeyouranswertoquestion4toyourparentandsay,“Hey,whydidn’tyouthinkaheadandbuymethiscoattheyearIwasborn???Lookatallthemoneywecouldhavesaved!”Asidefromthefactthatyourparenthadnowayofknowingyou’dwantaNorthFacealmosttwodecadeslater,yourparentdisagreeswithyourlogicandsaystherewouldn’thavebeenanysavingsbybuyingthecoatinyourbirthyear.Whyisyourparentmakingthisclaim?

6.Let’ssay,insteadofbuyingyouthecoatwhenyouwereborn,yourparentputmoney,equaltoyouranswerinquestion3,intoasavingsaccountthatearned1%interest.Wouldyoubeabletobuyyourcoattodaywiththosefunds?Whyorwhynot?Youcanusethiscompoundinterestcalculator ifyouneedto.

7.So,ifyourparentsomehowknew,thedayyouwereborn,thatyou’dsomedaywantaNorthFaceparkaforyourfirstyearofcollege,whatwouldheorshehaveneededtodo,financially,tohave$350forthecoattoday?

8.You’rethinkingalotaboutinflation,andyouthinkitmightbeagoodideatosetasidethemoneytobuyafancyleathercouchforyourfirsthome,whichyou’dliketopurchase10yearsafteryougraduatefromhighschool.Whydoestheinflationcalculatornottellyouwhattheinflationadjustedpricewillbe10yearsfromnow?

BONUS:TheNorthFaceisavailableacrossCanada,andinpartsofEurope,LatinAmerica,andAsia.WouldtheinflationcalculatorfromtheBureauofLaborStatisticsworktocalculatethehistoricalpriceofthatsameNorthFacejacketinothercountries?Whyorwhynot?Dosomeonlineresearchtosupportyouranswer.

HOMERELATED SITESDEFINITIONSFEATURED CONTENTABOUTUSFEEDBACK

SITEMAPSUBSCRIBE NOW

InflationData.com

YourPlaceinCyberSpaceforInflationData

NUMERICAL INFLATION DATAINFLATION CHARTSINFLATION CALCULATORS

INF.ADJUSTEDPRICESCOSTOFLIVINGBLOG

September17,2014fortheyearendingAugust 2014 | SeeourInflationCalculatoratInflationData.com | NextDataRe

YOUAREHERE:HOME»BLOG»INFLATION»THEIMPACTOFINFLATIONONSAVINGS

TheImpactofInflationonSavings

FEBRUARY5,2013BYTIMMCMAHON — LEAVEACOMMENT

$33.74

CustomBanner

upto50%off

Theobviousimpactofinflationonyour

savingsis thatthepurchasingpoweriserroded.Thismeansthatifyou stash$100under themattresstodayandinflationis3% peryearwhenyou comebackayearfromnowyour$100willbuy3%lessstuff. Putanotherwayyouwouldneed$103 to buythesameamount of goods ayearlater. Whenyouextendthis to10yearsyoumightthinkthatitwouldmeanthat youwouldneed$130to buythesameamountof goodsbut becauseoftheeffects ofcompoundingyou would actuallyneed$134.39.You

canusetheRetirementPlanningCalculatortocalculatetheimpactofinflation on your savings.

Astimegoesontheimpactof“only”3%inflationcompoundsmakingitevenworse.Even thoughhewasintimatelyacquainted with workings of theatombomb,Einsteincalledcompoundinterestthemostpowerfulforceon earth.

Unfortunately,compoundinflationis just likecompoundinterest workingagainstyou. Whenyoulookat theeffects of 3%inflationonyour savingsover25yearswefindthatpriceswill havemorethandoubled and youwillneed$209.38to buythesamebasketof goodsthat $100wouldbuy25yearsearlier.

InflationCausesUncertainty

Becausethevalueofyourmoneyisconstantlychanging,thismakesplanningforretirementespeciallydifficultsinceitislikeshooting atamovingtarget.Especially,sinceyoudon’tevenknowfor surewhat theannualinflation ratewill be.

Inflation-TheLeakingBucket

Overthelongrunsince1913inflationhasaveragedmorethan 3%(3.24%)so onaverageithastakenlessthan 22yearsforpricestodouble.Soasyouaresaving it isliketrying tofillabucketwhile3%is leakingout. Sotherefore,youhaveto putitinfaster thanitleaks out.

WhatAboutInterestonYourSavings?

Sofarwehaveonlylookedatsavingsthatwereputunderthemattress. Whatifyoudeposittheminthebank?Won’tthathelp?Iftheinterestrateisequaltotheinflationratethenitwouldbelikehavingasmallfaucetpouringwaterbackintoyourbucketat exactlytherateitwas leaking out.

Unfortunately,currentbankinterestratesareat historicallylowlevels,sothereisonlyadripgoingintoyourbankbucketfrom interestandsothelevelinthatbuckethas beendecliningalmost asfastasthemoneyunderthemattress.

Dependingon what youinvestin,someinvestments maydobetteror worsecomparedtoinflation.Commoditieslikegoldareoftenconsideredaninflationhedgeand over extremelylongperiodsgoldandsilverdoretaintheirpurchasingpower.But often duringtheshortrundistortionscanoccurandcausetheir valuetobecomeoveror under-priced. SeeIsGold anInflationHedge?Overthelast15yearsinflation hasbeenrelativelylowandgoldandsilverhaveoutperformedtheeffectsofinflation.But thatmaynotalwaysbethecase.Themajordisadvantageofcommodities is thattheydonotprovidea current incomeflowandsoyouareentirelydependentonappreciation keepingupwith inflation.

Realestateisanothercommoditythathasbeenthoughttodowellatkeepingupwithinflationwhichwastrueformanyyearsuntilthemarketbecameoverheatedandrealestatevaluesplunged.Solikeeverythingbuyingattherightpricepointisstillimportant.Likegoldifyouownyourownhomeitisnotproducingincome(althoughitmaybesavingyourent)butinvestmentpropertiescanprovidesomeprotectionagainstinflationandincomeatthesametime.

Whataboutstocks?

Onceagainthepriceofcompaniesshouldtheoreticallygrowsothatthecompanyretainsitsvalueagainstinflation.Butwhenyouinvestinstocksothervariablesareintroducedincludingstockspeculation(boomandbust),theabilityofthecompany’smanagementtodealwithchange,changingmarkettastesforthecompany’sproductsetc.

Quiteoftenstockswilloutperforminflationallowingyourinvestmenttomaintainitsvalueagainstinflationbutitisstillpossiblethatyouwillgetinatthetopandlosemoneyovertheshorttermorthatanyparticularcompanywillunder-performtheoverallmarket.Somestockspaydividendsinadditiontothepossibilityforstockpricegrowth.Stockdividendswouldactmuchliketheinteresthelpingtofillyourbucket,whiletheoreticallythestockpriceitselfshouldkeepupwithinflation.

WhataboutBonds?

Bondsaredebtobligationssimilartoputtingyourmoneyinabank.Youareonlyguaranteedtogetbackafixednumberofdollarsattheendofthelifeofthebond.Historically,bondsareconsideredtodopoorlyduringtimesofhighinflationbecauseofthis.Intimesofmoderateinflationifthe“couponrate”i.e.theinterestratethebondispayingishighenoughitcancounteracttheeffectsofinflation.

WhataboutInflationIndexedBonds?

Inflationindexedbondsaresupposedtobedesignedtotakeinflationintoconsiderationandcompensatethebondownerfortheeffectsofinflation.SeeHowHaveInflationIndexedBonds ReallyPerformed?formoreinformation.

OtherFactors

Oneoftheotherfactorsthatcanaffecttherealreturnyouexperienceaftertakingintoconsiderationtheeffectsofinflationistheeffectoftaxes.Inthefirstscenarioifyouhadputthemoneyunderthemattresstaxeswouldhavenoeffect.The$100wasaftertaxincomeandbecausetherewasnoadditionalincome,taxeswouldnotbeafactor.Inthebankscenariotaxeswouldbeminimalsinceinterestratesarecurrentlysosmallthemoneywouldhave

earnedverylittleandsotherewouldn’tbemuchtaxdue.