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August 5, 2014

Inflation is like dripping water.  When it starts, it is small, inconsequential and not too bothersome.  But, like the drip, it chips away over time until one day it causes a very noticeable problem.  Unlike the drip, it cannot be stopped if caught early; but if planned for, it won’t make as great a dent in your spending plans. Ignoring it can cause you later troubles.

Inflation can be considered the cost of doing nothing.  No matter how well we do or how secure you are or feel you are, there will be inflation.  [Actually, there might not always be inflation if there is a recession or depression, in which case we might be much worse off.  For the discussion here, I am assuming the best – that there will be reasonable inflation.]  Inflation is caused by increased costs and is determined by changes in the cost of living or consumer price index compiled by the federal government.  The slow and steady compounding of inflation’s increases works its nasty effects by making things we need cost more.

To illustrate the effect of inflation, $1,000 in 1988 would now only purchase $508 today, and $1,000 in 2003 would purchase $790 today.  Or ,to buy today what $1,000 would buy in 1988 or 2003 you would need $1,968 or $1,266.  When planning, you should assume the longest longevity period for yourself or at least one of the spouses if you are married.

To get a glimpse at your future spending, use your current amounts and make adjustments [in today’s dollars] for what you believe your future situation will be factoring in large one-time purchases such as for a car or home improvements or major maintenance.  Once that is done, determine the year you will start living on your investment income (as well as other sources such as Social Security or pensions), and then apply the inflation adjusted amounts in the previous paragraph for ten or 25 years.  For other periods, use a 2% annual inflation rate which is the approximate rate for the last twenty-five years. There are more exact ways to determine these amounts, but this should give you a quick idea of how you will fare later on in your life.

Regardless of overall inflation, each person has an individual inflation rate and consumption index.  Your individual inflation rate is based on what you buy and not the averages.  For instance, someone spending higher amounts on health care or college tuition will have a greater rate than the average.  The consumption index is based on the controllable portion of your spending, which can be changed if you need to by spending less than what you planned and anticipated when you set your goals.  This can be illustrated by eating out less, less entertainment, travel, clothing purchases, gifts to children or grandchildren, or moving to a lower cost residence (except if you need an assisted living facility) and less spending on non-necessities such as newspapers, books, extra cable stations and apps on your mobile phones.


Inflation is real.  Consider it in your planning.


One Comment leave one →
  1. 6hawthorne permalink
    August 5, 2014 2:19 pm


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