Your lifestyle is eroding and you don't even know it's happening. Inflation is robbing you of your buying power. A lot of people worry about higher inflation with massive government debt piling up in Washington. The reality is that you should have been worrying about inflation all along - before Obama, Bush, Clinton and even before Reagan. But if you take a few minutes to understand how inflation works, you can beat it.
Inflation is sneaky.
If you gain 3 to 4 pounds of weight every year, you won't notice it the first year, maybe not even the second year. But by the third year you'll need to move up a size or two in jeans, and after continuing that pattern for ten years you'll have a serious health problem. At that point, you become so concerned about your health, you go on a massive diet to get down to a healthy weight.
Inflation is like gaining weight. At 3% to 4%, inflation is barely noticeable from year to year, but over time the effect is staggering. 3.5% annual inflation equates to a 41% total price gain over ten years!
But unlike going on a diet, you can't "lose" inflation. You can't put prices back to where they were ten years ago. You're stuck with higher prices.
Inflation erodes your buying power.
A dollar today doesn't buy what it did ten years ago - and it will buy less in another ten years. A new Honda Accord LX Sedan had a base price of $15,495 in 1998. Ten years later that rose to $21,615 - a 3.4% increase per year. But since we only buy cars every few years, we don't notice it as much as when we got to the grocery store every week. In 1998 a gallon of milk was $2.29 a gallon and in 2008 that rose to $3.99 a gallon, rising 5.7% per year.
When your income is growing quickly, you don't see the effects of inflation, but it's still hurting you. When your income levels off or drops its effects are more painful. Add this to a consumption lifestyle and you can see why people get themselves into debt so easily just to make ends meet.
Inflation erodes your savings.
If your assets aren't growing faster than inflation, you'll never get ahead. If you keep your money in a bank savings account or CD's you're simply trading one risk for another. You won't have any fluctuation in your account value from month to month, but you risk losing your buying power. Buying CD's, which is not investing, is like treading water - you're not drowning, but you're not getting closer to land either. One of my clients refers to CD's as "certificates of depreciation."
People who create wealth know that beating inflation is an important task. A properly constructed portfolio of various assets - bonds, stocks, real estate and other specialized assets - can give you the growth potential to beat inflation while limiting your downside.
Many of our parents or grandparents put money aside from each paycheck to save up for major purchases they knew they would need in the future - cars, college educations, vacations, etc. They were making a conscious decision to forego spending that money on something they wanted at that moment so they could buy something they knew they needed in the future. That is exactly what financial planning and investing is all about - planning for future financial needs and being very intentional about funding those needs, and avoiding debt. This is the only way to beat inflation.