People are often afraid of low rates of return or bad investments, but we face a mostly automatic loss every year with inflation and novice investors commonly lose track of inflation in their retirement analysis.
People are often afraid of low rates of return or, even worse, losing money on an investment. Although this can potentially be a legitimate concern at face value, we often face a mostly automatic loss almost every year: inflation.
Inflation is the slow erosion of the purchasing power of your dollar. Or differently phrased: the value of the U.S. dollar most years becomes less and less valuable and simply doesn’t go as far.
Inflation in the last 100 years has averaged 3.39%, according to the U.S. Inflation Calculator. This means what you can buy this year for $100 will cost $103.39 next year if inflation matches the historical average over that 100-year period.
A good takeaway is that this is a silent killer on your cash accounts in most banks in this low interest rate environment. If your bank account is hypothetically returning 1% on your checking or savings account and inflation was 3%, you would be receiving a Real Return of -2%. (Real Return is an actual technical term for the adjustment of the nominal return by factoring in inflation which allows economists and investors to compare long term figures more apples to apples).
From a planning perspective, if liquidity is not a high need you would be better paying lower interest loans off to avoid that set interest and building your net worth by paying down liabilities instead of keeping your assets in cash and having it potentially lose value by sitting in the bank. If your risk tolerance and time horizon allow, you may also be better off attempting to out invest inflation in the stock market or another venture.
The most common area we see novice investors lose track of inflation is their retirement analysis. If you need $10,000 a month to live off now and plan to keep the same lifestyle, then you better believe you will need quite a bit more per month than that down the road to keep things status quo.
Whether investing, lending or borrowing, always make sure your thought process includes the influence of inflation on whatever outcome you are aiming to achieve.
Jon C. Ylinen is a Financial Advisor with North Star Resource Group and offers securities and investment advisory services through CRI Securities, LLC. and Securian Financial Services, Inc., Members FINRA/SIPC. CRI Securities, LLC. is affiliated with Securian Financial Services, Inc. and North Star Resource Group. North Star Resource Group is not affiliated with Securian Financial Services, Inc. Please consult a financial professional for specific advice in relation to your individual circumstances. This should not be considered as tax, specific loan repayment for an individual or legal advice. 710615/ DOFU 8-2013.