Monday, March 24, 2014

How Inflation Works (and why it matters)

Balloons, inflating, get it? Ahahaha.
Read this if: 

1) You want to know about a slightly more complex and significantly less exciting aspect of investing. 
2) You want another reason to motivate yourself to start investing (instead of just keeping your money in a bank account). 


I think we've all heard the term "inflation." I took an entire intro course on this and all I can tell you is this: as time goes on, things get cost more money to buy. I think everyone should have a general grasp of inflation, because it does impact your investments. 

A Super Simplified Example

Let’s say for example that I have $1000. In 2013, I put all of my money in a checking account that gives me 1% interest. Over a year, $1000 turns into $1010. But what does it matter if everything costs 3% more due to inflation? My money is not keeping up. Everything costs more now so even though I have $10 more, I can’t buy as much with it.

Here’s a concrete example based on inflation data: “…something that cost $100 in January of 1990 would cost $181.64 in September of 2012.” ( That seems like a pretty significant increase to me. 

Why This Is Important

We, as personal investors, want to make money from our investments. How much we make depends on what we invest in, but at the very least, we want to "beat" inflation. A checking account, savings account, or money market account won't offer rates that are competitive relative to inflation (in the long run). However, stocks and mutual funds tend to offer around 10% on average per year, according to CNN Money. That will hopefully always beat inflation. 

Bottom Line

If you're thinking about saving money in the long-term, make sure to take inflation into consideration. Keeping money in a savings account is great, and I encourage saving no matter what, but just know that investing in stocks and mutual funds can give you an edge in dealing with inflation. 

As always, contact me with questions or suggestions! 

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Photo Credit:  Dinner Series via photopin cc

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