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Seeds of Inspiration #11 Inflation Can Greatly Reduce Your Purchasing Power Over Time. If You Paid More For Your Last Car Than Your First House, Then You Know The Power of Inflation.

05/28/2021

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By Lars Olson, CFP®, ChSNC™, CPFA, CAP®, CRPS®
President, Wealth Advisor
Alluvial Private Wealth

May 28, 2021

It seems there is a lot of talk about inflation these days.  Inflation is the rising cost of goods from the gas pump to the grocery store.

Based on recent data, inflation has risen at a rate of about 2.6% in the 12-months ending in March 2021.  That may not sound too bad, however, in the 12-months through February 2021, the rate was 1.6%.  In just one month, the rate jumped from 1.6% to 2.6%, and that’s a lot.

To understand how inflation affects your purchasing power over time there’s a math shortcut known as the Rule of 72.  It’s a simple way to determine how long it would take for something to double in value - assuming it earns interest at a given rate.  Here are a few examples:

-        If growth is rising at 8% per year, divide 8 into 72, and you get 9.  That means it will take

9 years for something growing at 8% per year to double. 

-        Or let’s say something is growing at 12% per year.  Divide 12 into 72, and you get 6.  It takes 6 years for something growing at 12% per year to double.

Back to inflation.  At the 1.6% inflation rate from February – it would take prices 45 years to double.  At the 2.6% inflation rate from March – it only takes 27 years to double.  Seemingly small increases in the inflation rate will cause prices to double much more quickly.

Now, let’s think about inflation over a person’s lifetime.  Some of our clients paid more for their last car than they did for their first house.  In fact, one of our colleague’s parents paid just $6,500 for their first home in Toledo.  

Here’s the point – there’s lots of discussion about inflation.  The impact of inflation on your purchasing power is very real over the 30-or-so years you are retired.  It’s important to make sure that your financial plan includes a strategy for a rising income to protect your purchasing power against inflation.

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