{"id":1534,"date":"2009-12-18T18:01:34","date_gmt":"2009-12-18T12:31:34","guid":{"rendered":"http:\/\/www.niftylivecharts.com\/blog\/?p=1534"},"modified":"2009-12-18T18:01:34","modified_gmt":"2009-12-18T12:31:34","slug":"inflation-what-is-it-and-why-does-it-happen","status":"publish","type":"post","link":"https:\/\/www.niftylivecharts.com\/blog\/inflation-what-is-it-and-why-does-it-happen\/","title":{"rendered":"Inflation: What Is It And Why Does It Happen?"},"content":{"rendered":"
Inflation: What Is It And Why Does It Happen?<\/div>\n
“Inflation is the overall or specific increase in the cost<\/div>\n
of a good or service.”<\/div>\n
Inflation is when your mom or dad complains about the prices<\/div>\n
they have to pay nowadays compared to what they paid when<\/div>\n
they were a younger.<\/div>\n
“I remember when a candy bar only cost a nickel.” “I used<\/div>\n
to buy gas at that station for 15\u00a2 a gallon.” “When did<\/div>\n
milk get so expensive?” “You paid HOW much for your home?”<\/div>\n
Inflation in America has been relatively steady. There have<\/div>\n
been some periods of high inflation, such as was seen in the<\/div>\n
70’s, but on average inflation in the US has been steady at<\/div>\n
about 3% for the past 30 years. Some countries have<\/div>\n
experienced inflation above 1000% in a single year.<\/div>\n
The 3% figure is also pretty close to the average as you go<\/div>\n
further back in US history. So we will use the 3% figure as<\/div>\n
we discuss the effects of inflation.<\/div>\n
A detailed analysis of the cause of inflation is beyond the<\/div>\n
scope of this short article, but we can mention some things<\/div>\n
that tend to cause inflation.<\/div>\n
Increases in government taxes and fees can lead to inflation<\/div>\n
(especially when businesses are taxed). When the cost of<\/div>\n
business goes up, product prices go up. When prices go up<\/div>\n
your income effectively goes down. Then you have to work<\/div>\n
harder or find a better job. Or hope that your employer<\/div>\n
will give you a raise.<\/div>\n
Which then makes the business costs go up and so prices go<\/div>\n
up and so on.<\/div>\n
Also when your personal income taxes, property taxes, sales<\/div>\n
taxes, auto registration fees, etc. increase you are forced<\/div>\n
to live on less or hit the boss up for a raise.<\/div>\n
If you get your raise (and several of your co-workers also<\/div>\n
are given raises) the cost of doing business has gone up.<\/div>\n
The business will then pass the extra costs on to their<\/div>\n
customers – inflation.<\/div>\n
Inflation can also be caused by scarcity. If there are only<\/div>\n
a 10,000 Beanie-Babies, “Tickle-Me-Elmos”,<\/div>\n
“Chicken-Dance-Elmos”, or what ever the current toy-craze<\/div>\n
is, and there are 100,000 people that want one, the price is<\/div>\n
going to go up.<\/div>\n
If mad-cow disease causes cattle ranchers to destroy large<\/div>\n
portions of their herds and there is less beef on the<\/div>\n
market, the price of beef will go up.<\/div>\n
If interest rates go up, inflation can also result. If it<\/div>\n
costs more to borrow money, the cost of doing business has<\/div>\n
gone up and so will product and service prices.<\/div>\n
For the last 10 years inflation has been relatively low. It<\/div>\n
is my uneducated opinion that inflation has been minimal<\/div>\n
because people have relied on the stock market boom of the<\/div>\n
90s to supply extra cash. Also many people have taken on<\/div>\n
additional debt rather than curtail their spending.<\/div>\n
But people can only stand so much debt. Once you are maxed<\/div>\n
out on your ability to pay (you may never max out your<\/div>\n
credit limit as long as you keep paying on time), you will<\/div>\n
either have to reduce your lifestyle, beg for a raise or<\/div>\n
find a higher paying job.<\/div>\n
I predict that once the majority of middle-class America is<\/div>\n
saturated with debt, inflation will begin to rise or the<\/div>\n
economy will stagnate for years until some of the debt is<\/div>\n
paid down or people’s homes appreciate so that they can<\/div>\n
borrow more money against them. (Yes, you will be getting<\/div>\n
further into debt, but at least you can buy that new boat.)<\/div>\n
For the most part, regular, steady inflation has little<\/div>\n
effect on our day-to-day living. Most people get a pay<\/div>\n
raise every year or every other year that either keeps pace<\/div>\n
with inflation or helps them move a bit ahead.<\/div>\n
But when you are looking at the long run and making long<\/div>\n
term plans, inflation can have a big impact.<\/div>\n
For example if you are 30 right now, wouldn’t it be great to<\/div>\n
retire with a million dollars when you are 60. You could<\/div>\n
live on that forever. Right?<\/div>\n
Well, let’s factor in just 3% inflation for 30 years and see<\/div>\n
how much your million will buy then. After 30 years of 3%<\/div>\n
inflation, one million dollars will buy about $400,000 worth<\/div>\n
of goods and services. That’s 60% of your money gone to<\/div>\n
inflation.<\/div>\n
If you were counting on a monthly retirement amount of $2778<\/div>\n
each month for 30 years, you now only have the equivalent of<\/div>\n
$1111 each month. Less than half! Could you live on $1111<\/div>\n
a month?<\/div>\n
Sure you may have your home paid for and you won’t have to<\/div>\n
buy expensive work clothes or pay for lunch every day, but<\/div>\n
your medical bills will go up as you get older and your<\/div>\n
insurance costs will increase. Also you may want to golf or<\/div>\n
travel more than you do now. You will have more time for<\/div>\n
hobbies; how will you pay for them?<\/div>\n
The biggest problem I see with a lot of long range financial<\/div>\n
planning, especially retirement planning, is that people<\/div>\n
forget to factor in the effect of inflation on their<\/div>\n
investments and savings.<\/div>\n
You may be able to live on $2778 a month at today’s prices,<\/div>\n
but could you live on $1111 at what prices could be 30 years<\/div>\n
from now.<\/div>\n
So what can you do about inflation? Really nothing. It is<\/div>\n
out of your hands.<\/div>\n
But when planning for the future you can include it in your<\/div>\n
calculations. If you want to live on the equivalent of<\/div>\n
$2778 a month when you retire 30 years from now, you need to<\/div>\n
plan to save\/accumulate $1.8 million and have it invested at<\/div>\n
5% after you retire and want it to last 30 years.<\/div>\n
That means that if you are earning 11% (as the stock market<\/div>\n
has averaged for the last 30 years) and you are 30 now, you<\/div>\n
will have to invest $500 each month to achieve this goal.<\/div>\n
If you only invest $100 a month you will need an average<\/div>\n
return of 18.4%. (If you can average that, you should be<\/div>\n
managing the world’s money!)<\/div>\n
A good financial planner will understand the effects of<\/div>\n
inflation and help you plan for them. But I suspect that<\/div>\n
some less-trained “planners” (who are probably more like<\/div>\n
salespeople in a financial planner suit) tend to “forget”,<\/div>\n
ignore or don’t understand in the first place the effects of<\/div>\n
inflation.<\/div>\n
Leaving it out of the plan makes the calculations easier and<\/div>\n
may even help them get more “sales” because you are not<\/div>\n
discouraged by the truth. And their “product” (investment)<\/div>\n
may not seem as inadequate as it may really be.<\/div>\n
Another quick way to account for the effect of inflation is<\/div>\n
to subtract the inflation rate from any rate of interest you<\/div>\n
will be receiving on an investment. So if you are going to<\/div>\n
assume a 3% inflation rate and the assumed rate of return is<\/div>\n
11%, do the projection with only a 8% rate of return or<\/div>\n
interest.<\/div>\n
This will give you a more accurate picture of the value (not<\/div>\n
the amount) of the investment at its maturity.<\/div>\n
Some investments such as real estate and precious metals<\/div>\n
(gold, silver, etc.) actually benefit from inflation. This<\/div>\n
may make you want to truly “diversify” your portfolio into<\/div>\n
more types of assets, not just more types of stock.<\/div>\n
Inflation does not have to be scary as long as you<\/div>\n
understand how it works and how it affects your future money<\/div>\n
values. Accounting for it in financial equations and<\/div>\n
projections can be done simply. But overlooking it or<\/div>\n
downplaying its effects can cause you to miss your financial<\/div>\n
goals by a wide margin.<\/div>\n

“Inflation is the overall or specific increase in the cost\u00a0of a good or service.”\u00a0Inflation is when your mom or dad complains about the price\u00a0they have to pay nowadays compared to what they paid when<\/p>\n

they were a younger.<\/p>\n

A detailed analysis of the cause of inflation is beyond the\u00a0scope of this short article, but we can mention some things\u00a0that tend to cause inflation.Increases in government taxes and fees can lead to inflation(especially when businesses are taxed). When the cost of\u00a0business goes up, product prices go up. When prices go up\u00a0your income effectively goes down. Then you have to work\u00a0harder or find a better job. Or hope that your employer\u00a0will give you a raise.\u00a0Which then makes the business costs go up and so prices go\u00a0up and so on.<\/p>\n

Also when your personal income taxes, property taxes, sales\u00a0taxes, auto registration fees, etc. increase you are forced\u00a0to live on less or hit the boss up for a raise.\u00a0If you get your raise (and several of your co-workers also\u00a0are given raises) the cost of doing business has gone up.\u00a0The business will then pass the extra costs on to their\u00a0customers – inflation.<\/p>\n

Inflation can also be caused by scarcity. If there are only\u00a0a 10,000 Beanie-Babies, “Tickle-Me-Elmos”,\u00a0“Chicken-Dance-Elmos”, or what ever the current toy-craze\u00a0is, and there are 100,000 people that want one, the price is\u00a0going to go up.If mad-cow disease causes cattle ranchers to destroy large\u00a0portions of their herds and there is less beef on themarket, the price of beef will go up.\u00a0If interest rates go up, inflation can also result. If it\u00a0costs more to borrow money, the cost of doing business has\u00a0gone up and so will product and service prices.<\/p>\n

For the most part, regular, steady inflation has little\u00a0effect on our day-to-day living. Most people get a pay\u00a0raise every year or every other year that either keeps pace<\/p>\n

with inflation or helps them move a bit ahead.\u00a0But when you are looking at the long run and making long\u00a0term plans, inflation can have a big impact.\u00a0For example if you are 30 right now, wouldn’t it be great to\u00a0retire with a million dollars when you are 60. You could\u00a0live on that forever. Right?\u00a0Well, let’s factor in just 3% inflation for 30 years and see\u00a0how much your million will buy then. After 30 years of 3%\u00a0inflation, one million dollars will buy about $400,000 worth \u00a0of goods and services. That’s 60% of your money gone to\u00a0inflation.<\/p>\n

So what can you do about inflation? Really nothing. It is\u00a0out of your hands.<\/p>\n

A good financial planner will understand the effects of\u00a0inflation and help you plan for them. But I suspect that\u00a0some less-trained “planners” (who are probably more like\u00a0salespeople in a financial planner suit) tend to “forget”,\u00a0ignore or don’t understand in the first place the effects of\u00a0inflation.<\/p>\n

Leaving it out of the plan makes the calculations easier and\u00a0may even help them get more “sales” because you are not\u00a0discouraged by the truth. And their “product” (investment)\u00a0may not seem as inadequate as it may really be.Another quick way to account for the effect of inflation is\u00a0to subtract the inflation rate from any rate of interest you\u00a0will be receiving on an investment. So if you are going to\u00a0assume a 3% inflation rate and the assumed rate of return is\u00a011%, do the projection with only a 8% rate of return or\u00a0interest.<\/p>\n

This will give you a more accurate picture of the value (not\u00a0the amount) of the investment at its maturity.Some investments such as real estate and precious metals\u00a0(gold, silver, etc.) actually benefit from inflation. This\u00a0may make you want to truly “diversify” your portfolio into\u00a0more types of assets, not just more types of stock.Inflation does not have to be scary as long as you\u00a0understand how it works and how it affects your future money\u00a0values. Accounting for it in financial equations and\u00a0projections can be done simply. But overlooking it or\u00a0downplaying its effects can cause you to miss your financial\u00a0goals by a wide margin.<\/p>\n","protected":false},"excerpt":{"rendered":"

Inflation: What Is It And Why Does It Happen? “Inflation is the overall or specific increase in the cost of a good or service.” Inflation is when your mom or dad complains about the prices they have to pay nowadays compared to what they paid when they were a younger. “I remember when a candy […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","footnotes":""},"categories":[1],"tags":[4500,4502,4503,1017,4501],"class_list":{"0":"post-1534","1":"post","2":"type-post","3":"status-publish","4":"format-standard","6":"category-general","7":"tag-defaltion","8":"tag-effects-of-inflation","9":"tag-impact-of-inflation-on-economy","10":"tag-inflation","11":"tag-meaning-of-inflation","12":"entry"},"_links":{"self":[{"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/posts\/1534","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/comments?post=1534"}],"version-history":[{"count":0,"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/posts\/1534\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/media?parent=1534"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/categories?post=1534"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.niftylivecharts.com\/blog\/wp-json\/wp\/v2\/tags?post=1534"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}