Something's Eating Your Money!

This dollar bill has a DISEASE.

It might seem healthy, but if you look real close, you’ll see a virus that is slowly but surely eating away it’s purchasing power every day.

This particular virus is named inflation, and every dollar in your bank account is infected with it.

If you’ve ever taken a high school economics class, you’ve probably already heard the term.

But most of us only know that it’s the reason one day we’ll tell our grandkids “Back in my day, Macbook Pro’s only cost one bitcoin”!

But inflation isn’t just some benign force.

It’s why getting a raise is so important, why the cost of education is spiraling out of control and in extreme examples, it’s affecting millions of people’s ability to put food on the table.

And it’s something you need to learn how to live alongside without letting it sideline your financial goals!

Now, inflation wouldn’t be such a big deal if everything inflated at the exact same rate.

Who cares if housing prices skyrocketed if your salary instantly compensated to match.

The problem arises because different things inflate at different rates and sometimes for completely different reasons.

There are two main types.

The first is cost-push inflation.

This is when companies are forced to raise prices because the cost of the materials to make the thing or provide the service has gone up.

For example, did you happen to notice how vanilla ice cream is getting more expensive?

Madagascar, the world’s largest supplier, has been consistently hit with terrible storms that have been destroying the delicate crop.

So if the companies relying on vanilla want to keep their profit margins the same, they will have to consider pushing that increased cost onto their customers in the form of a higher price.

Which they can get away with to a certain point, assuming the economy is healthy enough for it to not affect demand too dramatically.

Then there’s demand-pull inflation.

Take our hometown Austin.

It’s a rapidly growing city but the supply of housing hasn’t been able to match the demand.

Meaning landlords and people selling their homes are in the position to ask for higher prices than they did the year before.

While both of these examples aren’t super fun on our wallet, inflation is in many scenarios related to growth.

When an economy is growing, the overall demand for goods goes up.

Conversely, when the economy isn’t going well inflation tends to decrease because there’s not enough demand to support a price increase.

But, like a virus, if inflation is allowed to run rampant, really really bad things can happen.

Take Venezuela.

Corruption combined with economic mismanagement and an authoritarian government has led to a humanitarian crisis of epic proportions.

The hyperinflation is so bad that the government refuses to share any official numbers, so Bloomberg created “the Cafe Con Leche index” measuring the price of a cup of coffee in eastern Caracas.

In March of 2018 that cup of coffee cost 1.2 Bolivars and just one year later, that same cup cost 2,800 bolivars.

It’s no wonder that at nearly a third of the population has left the country.

So, whose job is it to make sure that doesn’t happen?

Here in the US it’s the Federal Reserve.

The Fed, is the bank of banks and its job is essentially to walk a tightrope between encouraging the economy to grow, aka, allowing prices to rise, but at the same time, keeping inflation from gaining too much ground and taking away the purchasing power of its citizens.

The Fed tries to fight inflation in three different ways: Setting the interest rate that banks borrow money from them, adjusting how much cash banks are required to have on hand, and deciding how much new money can be printed.

These methods control how much money is floating around the economy.

The more money floating around, the more liberal banks feel about lending it out, so interest rates go down.

Which means it’s easier for people like you and me to get a mortgage, a credit card, a student or small business loan, and the economy grows.

But if it grows too fast, prices will go up faster than wages can keep pace—and your savings are suddenly worth a lot less.

That money you set aside for a Hawaiian vacation will now only get you as far as San Antonio.

There’s no question that regulating inflation on macro-economic level is massively complicated.

Thankfully, Unless you’re current Federal Reserve Chairman Jerome Powell, you don’t have any control over it.

But on the micro-economic level it’s your job to inoculate yourself.

And guess what, there’s only one vaccine out there, investing.

Most people know they should invest…but why?

Why can’t you simply save your way into wealth?

I think it’s time to… Run the numbers!

This is Tricia.

She feels sort of scared of the stock market and travels a lot so she doesn’t feel like owning real estate for the foreseeable future.

What if she wanted to try and save money into a checking account to get to her personal retirement goal of 850,000 dollars?

If inflation didn’t exist, it would be pretty simple algebra.

If she started saving at 30 and wanted to retire at 65 that would require her to save $2,023 per month in order to hit her nest egg goal.

A challenging number to hit even for higher earners.

But the reality with inflation is way worse.

The Fed’s goal is to keep inflation at around 2 percent per year.

So let’s say that actually happens.

That means in order to keep the same purchasing power of 850,000 in the future, her new goal will have to be adjusted to almost 1.7 million dollars.

That would require her to set aside double the money or the equivalent of $4,047 per month.

Yikes!

But if Tricia decided to educate herself a bit and move past her investing fears, she could harness the same forces that created the inflation in the first place to her benefit.

If she decided to invest her way to retirement through some stock-based mutual funds with an average return of 8% per year, she could still hit that 1.6 million dollar goal, by only saving $822/month.

Ok, while that’s not chump change, that sounds WAY more realistic than four grand a month!

It’s also important for Tricia to keep a close eye on her income.

If it doesn’t increase to keep pace with inflation, she’s essentially making less money every year, even if her salary stays the same.

So instead of seeing inflation as an evil virus, let’s think of it like another invisible powerful force, the wind.

You can choose to work against it or hoist a sail and let the forces at play work on your behalf.

And that’s our two cents!