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This dollar bill has a DISEASE.
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It might seem healthy, but if you look real
close, you’ll see a virus that is slowly
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but surely eating away it’s purchasing power
every day.
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This particular virus is named inflation,
and every dollar in your bank account is infected with it.
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If you’ve ever taken a high school economics
class, you’ve probably already heard the term.
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But most of us only know that it’s the reason
one day we’ll tell our grandkids “Back
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in my day, Macbook Pro’s only cost one bitcoin”!
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But inflation isn’t just some benign force.
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It’s why getting a raise is so important, why the
cost of education is spiraling out of control
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and in extreme examples, it’s affecting
millions of people’s ability to put food
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on the table.
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And it’s something you need to learn how
to live alongside without letting it sideline
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your financial goals!
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Now, inflation wouldn’t be such a big deal
if everything inflated at the exact same rate.
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Who cares if housing prices skyrocketed if
your salary instantly compensated to match.
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The problem arises because different things
inflate at different rates and sometimes for
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completely different reasons.
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There are two main types.
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The first is cost-push inflation.
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This is when companies are forced to raise
prices because the cost of the materials to
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make the thing or provide the service has
gone up.
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For example, did you happen to notice how
vanilla ice cream is getting more expensive?
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Madagascar, the world’s largest supplier,
has been consistently hit with terrible storms
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that have been destroying the delicate crop.
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So if the companies relying on vanilla want
to keep their profit margins the same, they
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will have to consider pushing that increased
cost onto their customers in the form of a
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higher price.
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Which they can get away with to a certain
point, assuming the economy is healthy enough
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for it to not affect demand too dramatically.
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Then there’s demand-pull inflation.
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Take our hometown Austin.
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It’s a rapidly growing city but the supply
of housing hasn’t been able to match the
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demand.
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Meaning landlords and people selling their
homes are in the position to ask for higher
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prices than they did the year before.
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While both of these examples aren’t super
fun on our wallet, inflation is in many scenarios
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related to growth.
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When an economy is growing, the overall demand
for goods goes up.
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Conversely, when the economy isn’t going
well inflation tends to decrease because there’s
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not enough demand to support a price increase.
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But, like a virus, if inflation is allowed
to run rampant, really really bad things can happen.
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Take Venezuela.
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Corruption combined with economic mismanagement
and an authoritarian government has led to
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a humanitarian crisis of epic proportions.
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The hyperinflation is so bad that the government
refuses to share any official numbers, so
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Bloomberg created “the Cafe Con Leche index”
measuring the price of a cup of coffee in
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eastern Caracas.
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In March of 2018 that cup of coffee cost 1.2
Bolivars and just one year later, that same
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cup cost 2,800 bolivars.
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It’s no wonder that at nearly a third of
the population has left the country.
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So, whose job is it to make sure that doesn’t
happen?
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Here in the US it’s the Federal Reserve.
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The Fed, is the bank of banks and its job
is essentially to walk a tightrope between
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encouraging the economy to grow, aka, allowing
prices to rise, but at the same time, keeping
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inflation from gaining too much ground and
taking away the purchasing power of its citizens.
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The Fed tries to fight inflation in three
different ways: Setting the interest rate
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that banks borrow money from them, adjusting
how much cash banks are required to have on
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hand, and deciding how much new money can
be printed.
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These methods control how much money is floating
around the economy.
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The more money floating around, the more liberal
banks feel about lending it out, so interest
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rates go down.
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Which means it’s easier for people like
you and me to get a mortgage, a credit card,
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a student or small business loan, and the
economy grows.
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But if it grows too fast, prices will go up
faster than wages can keep pace—and your
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savings are suddenly worth a lot less.
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That money you set aside for a Hawaiian vacation
will now only get you as far as San Antonio.
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There’s no question that regulating inflation
on macro-economic level is massively complicated.
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Thankfully, Unless you’re current Federal
Reserve Chairman Jerome Powell, you don’t
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have any control over it.
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But on the micro-economic level it’s your
job to inoculate yourself.
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And guess what, there’s only one vaccine
out there, investing.
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Most people know they should invest…but
why?
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Why can’t you simply save your way into
wealth?
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I think it’s time to…
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Run the numbers!
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This is Tricia.
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She feels sort of scared of the stock market
and travels a lot so she doesn’t feel like
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owning real estate for the foreseeable future.
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What if she wanted to try and save money into
a checking account to get to her personal
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retirement goal of 850,000 dollars?
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If inflation didn’t exist, it would be pretty
simple algebra.
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If she started saving at 30 and wanted to
retire at 65 that would require her to save
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$2,023 per month in order to hit her nest
egg goal.
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A challenging number to hit even for higher
earners.
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But the reality with inflation is way worse.
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The Fed’s goal is to keep inflation at around
2 percent per year.
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So let’s say that actually happens.
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That means in order to keep the same purchasing
power of 850,000 in the future, her new goal
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will have to be adjusted to almost 1.7 million
dollars.
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That would require her to set aside double
the money or the equivalent of $4,047 per month.
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Yikes!
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But if Tricia decided to educate herself a
bit and move past her investing fears, she
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could harness the same forces that created
the inflation in the first place to her benefit.
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If she decided to invest her way to retirement
through some stock-based mutual funds with
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an average return of 8% per year, she could
still hit that 1.6 million dollar goal, by
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only saving $822/month.
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Ok, while that’s not chump change, that
sounds WAY more realistic than four grand
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a month!
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It’s also important for Tricia to keep a
close eye on her income.
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If it doesn’t increase to keep pace with
inflation, she’s essentially making less
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money every year, even if her salary stays
the same.
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So instead of seeing inflation as an evil
virus, let’s think of it like another invisible
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powerful force, the wind.
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You can choose to work against it or hoist
a sail and let the forces at play work on
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your behalf.
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And that’s our two cents!
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Thanks to our patrons for keeping Two Cents financially healthy.
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Click the link in the description if you'd like to support us on Patreon.
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Have you noticed the effect of inflation in
your life?
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Tell us about it in the comments.
