You Should Care About Inflation

by Miranda Marquit · 11 comments

One of financial realities that many forget to consider is inflation. This is because inflation is relatively sneaky. You don’t see it in your taxes, and you don’t write a separate check for it. Instead, inflation manifests itself as a subtle reduction in your purchasing power. Think about what you could buy with $5 10 years ago compared to what $5 will get you today. I remember when you could buy penny candies and when gas was right around $1 a gallon. Those days are long gone — thanks to inflation.

What is Inflation?

Simply put, inflation is the way that prices rise over time. Inflation is usually described as rising prices, or a decline in the value of dollars. Either way, your purchasing power is eroded and you have to spend more money to get the same amount. In some cases, such as with packaged food, you spend the same amount of money to get a smaller quantity. No matter how you look at it, inflation makes sure that your money doesn’t go as far as it used to.

There is no universal agreement on what causes inflation. There are some theories floating around, though. Some of the things that likely contribute to inflation include:

  1. High Demand: If there is a great demand for something, but not enough supply to meet that demand, prices rise on what is available.
  2. Increased Costs: Businesses that see increased costs are likely to pass those on in order to maintain profit margins. These costs can include increased cost of benefits, higher wages for employees and costlier imports.
  3. Too Much Money: We have a fiat currency, rather than one that is based on something tangible. People talk about monetary policymakers “printing money.” The increases in one country’s money supply decreases its value and hence the cost of goods from other countries will become more expensive, leading to higher prices.
  4. Easy Credit: The ability to access credit can also contribute to higher prices, since being able to buy more expensive items with borrowed money can mean that it is possible for merchants to raise prices. After all, who cares about price increases when customers aren’t sensitive to affordability?

Whatever the causes of inflation, its effects can be very real, and affect you in the future.

Inflation Affects Your Finances

Obviously, when prices rise you feel it in your pocketbook. You have probably noticed changes in your budget due to recently rising food and gas prices. When you have to spend more money on things that you need, it is harder to find discretionary income for things that you want. Inflation can make it difficult to make ends meet — especially if wages haven’t kept pace with inflation (as has been the case in recent years).

When planning for retirement, it is important to factor in the effects of inflation. You might think that you will be fine if you save up $1 million, but the fact of the matter is that $1 million will not go as far in 30 years as it does right now. You might need to adjust your expectations, and your retirement savings plan, to cope with this reality. Health care, food and energy are items that are sure to rise in the future. Other items are also likely to cost more down the road.

As you prepare for the future, consider what you can do to protect yourself from inflation. This can mean diversifying your investments so that you get better returns, or engaging in other measures meant to protect you from inflation. Because inflation is inevitable, it is vital that you consider it when making financial calculations.

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{ 11 comments… read them below or add one }

Ken Faulkenberry April 5, 2011 at 7:12 am

I believe ALL inflation is caused by #3 – Too Much Money printed by central banks. High demand, Increased costs, and easy credit are all symptoms of Too Much Money.
Your main point it the important one. Inflation affects your finances and you must plan for inflation. Short term inflation can squeeze our budgets, but long term inflation can DEVASTATE your retirement plans.
In addition to acknowledging and understanding inflation, it’s important to make adjustments in your portfolio asset allocation to reflect today’s new reality.
Thank you.
Ken Faulkenberry
AAAMPblog.com

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Wade April 5, 2011 at 9:31 am

I hate inflation. I also remember when gas was around a dollar. I’m sure that part of what leads to inflation is the access to natural resources, like oil, that impact nearly every aspect of a business. When gas prices rise, all of the sudden business are paying more money for transportation of the products from the raw materials to the final product. Chances are pretty good that these increased costs will be reflected in the price that the consumer pays for the product.

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Hunter April 5, 2011 at 9:53 am

Inflation sux. It slams people on fixed incomes, even those indexed to inflation. Real world prices increase more rapidly than the CPI reports. Anyone that buys groceries knows this…apparently civil servants don’t.

Many people think that high inflation is the only way the U.S. will be able to meet it’s debt obligations. I wonder what our Chinese bankers think about this?

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marci April 5, 2011 at 1:48 pm

“Instead, inflation manifests itself as a subtle reduction in your purchasing power.”

That would lead me to believe that the secret to Not being much affected by purchasing power would be to NOT need to purchase much :)

The less you need to buy, the better off you will be – if you follow this line of reasoning. Use less, consume less… Make more, Produce more yourself. I realize there are limits to that…. but basicially, live simply, do it yourself as much as possible, quit spending as much as possible, and enjoy life.

Be a Producer – Not a Consumer. There-in lies the answer.
It’s what my kids were taught, and now I am teaching my grandkids the same.

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Hunter April 5, 2011 at 5:51 pm

Marci: I love your philosophy. Consume less. So simple, and yet it would solve so many of our problems. I strongly agree.

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MoneyNing April 5, 2011 at 6:24 pm

Marci: I know I can count on you for incredible, simple, yet effective solutions. Whatever you aren’t buying won’t hurt if they raise prices.

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marci357 April 5, 2011 at 6:36 pm

Yes, guys…. I just live in my own little world :)

Actually – this is a great reason for you to try your best to become debt free…
When you are down to utilities, insurance, taxes, and maintenance, life gets a lot less complicated :)

Between my sewing machine, garden, firewood gathering, and my black and decker electric drill (every girl’s best friend), I can handle a lot of the little problems along the way without spending much money :)

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MoneyNing April 5, 2011 at 9:19 pm

Ha. My debt free present might just be a Black and Decker electric drill.

I wouldn’t know how to use it though since I’m not very handy, but everyone starts at zero right?

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marci April 6, 2011 at 1:45 pm

Yes :) Every one starts at zero…. check out a couple books from the library on do it yourself stuff, or get online demos… That’s how I mostly learned.

Also – get the box of attachments and drill bits that go with it. It’s an orange and clear box, about 10x 12 inches, with bits, circle cut out thingies ( :)) and bigger bits for drilling wood holes, (auger bits?) and allen wrenches and a punch, etc. All those little things help :) I don’t have to know what they are all called, just how to use them :)

My 10 yr old granddaughter is getting fairly good at using it also – under supervision, of course :)

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marci April 6, 2011 at 1:46 pm

the box of stuff goes on sale every so often for $19.99 or so.

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Roger @ The Chicago Financial Planner October 14, 2012 at 6:44 am

Excellent post I couldn’t agree more with what you said, especially your your comments on the potential impact on retirees. I think we have been lulled to sleep by the low inflation of recent years, but at some point I suspect inflation will return. We all need to be prepared.

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