Inflation,amp,#58,What,And,Why finance, share, loan Inflation: What Is It And Why Does It Happen&#63

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"Inflation is the overall or specific increase in the costof a good or service."Thank you, Mr. Dictionary.Inflation is when your mom or dad complains about the pricesthey have to pay nowadays compared to what they paid whenthey were a younger."I remember when a candy bar only cost a nickel." "I usedto buy gas at that station for 15¢ a gallon." "When didmilk get so expensive?" "You paid HOW much for your home?"Inflation in America has been relatively steady. There havebeen some periods of high inflation, such as was seen in the70's, but on average inflation in the US has been steady atabout 3% for the past 30 years. Some countries haveexperienced inflation above 1000% in a single year.The 3% figure is also pretty close to the average as you gofurther back in US history. So we will use the 3% figure aswe discuss the effects of inflation.A detailed analysis of the cause of inflation is beyond thescope of this short article, but we can mention some thingsthat tend to cause inflation.Increases in government taxes and fees can lead to inflation(especially when businesses are taxed). When the cost ofbusiness goes up, product prices go up. When prices go upyour income effectively goes down. Then you have to workharder or find a better job. Or hope that your employerwill give you a raise.Which then makes the business costs go up and so prices goup and so on.Also when your personal income taxes, property taxes, salestaxes, auto registration fees, etc. increase you are forcedto live on less or hit the boss up for a raise.If you get your raise (and several of your co-workers alsoare given raises) the cost of doing business has gone up.The business will then pass the extra costs on to theircustomers - inflation.Inflation can also be caused by scarcity. If there are onlya 10,000 Beanie-Babies, "Tickle-Me-Elmos","Chicken-Dance-Elmos", or what ever the current toy-crazeis, and there are 100,000 people that want one, the price isgoing to go up.If mad-cow disease causes cattle ranchers to destroy largeportions of their herds and there is less beef on themarket, the price of beef will go up.If interest rates go up, inflation can also result. If itcosts more to borrow money, the cost of doing business hasgone up and so will product and service prices.For the last 10 years inflation has been relatively low. Itis my uneducated opinion that inflation has been minimalbecause people have relied on the stock market boom of the90s to supply extra cash. Also many people have taken onadditional debt rather than curtail their spending.But people can only stand so much debt. Once you are maxedout on your ability to pay (you may never max out yourcredit limit as long as you keep paying on time), you willeither have to reduce your lifestyle, beg for a raise orfind a higher paying job.I predict that once the majority of middle-class America issaturated with debt, inflation will begin to rise or theeconomy will stagnate for years until some of the debt ispaid down or people's homes appreciate so that they canborrow more money against them. (Yes, you will be gettingfurther into debt, but at least you can buy that new boat.)For the most part, regular, steady inflation has littleeffect on our day-to-day living. Most people get a payraise every year or every other year that either keeps pacewith inflation or helps them move a bit ahead.But when you are looking at the long run and making longterm plans, inflation can have a big impact.For example if you are 30 right now, wouldn't it be great toretire with a million dollars when you are 60. You couldlive on that forever. Right?Well, let's factor in just 3% inflation for 30 years and seehow much your million will buy then. After 30 years of 3%inflation, one million dollars will buy about $400,000 worthof goods and services. That's 60% of your money gone toinflation.If you were counting on a monthly retirement amount of $2778each month for 30 years, you now only have the equivalent of$1111 each month. Less than half! Could you live on $1111a month?Sure you may have your home paid for and you won't have tobuy expensive work clothes or pay for lunch every day, butyour medical bills will go up as you get older and yourinsurance costs will increase. Also you may want to golf ortravel more than you do now. You will have more time forhobbies; how will you pay for them?The biggest problem I see with a lot of long range financialplanning, especially retirement planning, is that peopleforget to factor in the effect of inflation on theirinvestments and savings.You may be able to live on $2778 a month at today's prices,but could you live on $1111 at what prices could be 30 yearsfrom now.So what can you do about inflation? Really nothing. It isout of your hands.But when planning for the future you can include it in yourcalculations. If you want to live on the equivalent of$2778 a month when you retire 30 years from now, you need toplan to save/accumulate $1.8 million and have it invested at5% after you retire and want it to last 30 years.That means that if you are earning 11% (as the stock markethas averaged for the last 30 years) and you are 30 now, youwill have to invest $500 each month to achieve this goal.If you only invest $100 a month you will need an averagereturn of 18.4%. (If you can average that, you should bemanaging the world's money!)A good financial planner will understand the effects ofinflation and help you plan for them. But I suspect thatsome less-trained "planners" (who are probably more likesalespeople in a financial planner suit) tend to "forget",ignore or don't understand in the first place the effects ofinflation.Leaving it out of the plan makes the calculations easier andmay even help them get more "sales" because you are notdiscouraged by the truth. And their "product" (investment)may not seem as inadequate as it may really be.Another quick way to account for the effect of inflation isto subtract the inflation rate from any rate of interest youwill be receiving on an investment. So if you are going toassume a 3% inflation rate and the assumed rate of return is11%, do the projection with only a 8% rate of return orinterest.This will give you a more accurate picture of the value (notthe amount) of the investment at its maturity.Some investments such as real estate and precious metals(gold, silver, etc.) actually benefit from inflation. Thismay make you want to truly "diversify" your portfolio intomore types of assets, not just more types of stock.Inflation does not have to be scary as long as youunderstand how it works and how it affects your future moneyvalues. Accounting for it in financial equations andprojections can be done simply. But overlooking it ordownplaying its effects can cause you to miss your financialgoals by a wide margin.