Factoring Inflation Into Your Financial Plans

One of the reasons that investing is such an important part of your financial plans, including retirement planning, is inflation. Inflation is basically (in very simplistic terms) how fast prices rise. It’s how fast things increase in cost. And one term you hear about now is core inflation. Daniel Gross explains core inflation in Newsweek:

Catch that bit about “core inflation”? That’s Fedspeak for: inflation is under control, unless you look at the costs of things that are going up. The core rate excludes the prices of food and energy, which can be volatile from month to month.

But as you probably realize, food energy are two things that make up a major part of your budget. Which is why you need to keep inflation in mind. With wages basically stagnant, you should realize that things are going to keep costing more, even as your income remains relatively stable. Living within your means and investing are two ways to outstrip inflation. And it means that you shouldn’t just be reassured by core inflation figures. Occasionally look at what the entire picture is doing, including in areas like energy, food, healthcare and education where costs rise faster than other consumer areas.

Inflation will also affect your retirement planning. Last week we looked at how much one could get if one invested $1 a week instead of playing the lottery. Logan Flatt, CFA pointed out in a comment that the results, though impressive, only showed the nominal amount you would get, rather than the actual value of the money you accumulated:

To get to the real results, you must reduce your annual return assumptions by a further assumed annual rate of inflation for prices in the general economy.

Translation: subtract the amount of money gobbled up by inflation from your yearly gains.

So remember: inflation is real factor when it comes to yielding wealth. Including prudent investments in a diversified portfolio is important so that your earnings aren’t completely swallowed by the monster of inflation.