ARFS - Introduction - Did Someone Say Inflation ?

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

Editor's Note: This post was published at the Carnival of Personal Finance #73.

[Continued from ARFS - Introduction - Oh My Secured Social Security!]

In simple terms inflation has been defined as a process of continuously rising prices, or equivalently, of a continuously falling value of money. How significant is it? Let us take an example.

What cost $100 in 1975 would cost $374.56 in 2005.

Also, if you were to buy exactly the same products in 2005 and 1975,
they would cost you $100 and $26.70 respectively.

Source: http://www.westegg.com/inflation

From our investing perspective let us say we dropped a $100 bill in a cookie jar in 1975. Fast forward. Miraculously in 2005 we discovered that bill intact in the jar. Though it still is a $100 bill, but there is a significant difference. Whatever we could buy with it in 2005 could have been bought with just $26.70 back in 1975. The value of $100 dropped from $100 to $26.70 in 30 years with respect to the purchasing power in 1975! That is a 4.5% annual inflation drop.

Figure 4 shows the annual inflation rate and 12 month moving average of inflation in US. Please note that we are in a period where the inflation has been rising for the last 4 years which is a cause of serious concern for our investment strategies. How aggressive do we need to be to meet our goals?

Figure 4: Annual Inflation Rate

[Please click on the above picture to see a bigger and clearer version of it]

Source: http://inflationdata.com/inflation/Inflation_Rate/AnnualInflation.asp

After looking at various inflation numbers of the past we decided to factor in an inflation rate of 4% for our financial planning. Thus we have to at least grow our money at 4% just to maintain its current purchasing power.

To get a realistic picture, let us assume that we could retire today if we had $2 million in liquid net worth. Now at 4% inflation rate we would need $4.38 million at the end of 20 years or $6.49 million at the end of 30 years to give us purchasing power equivalent to $2 million in today’s value! We better be serious and start early.

Information and Tools

• Historical inflation data can be found at: http://inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx

• Inflation calculator: http://inflationdata.com/inflation/Invflation_Rate/InflationCalculator.asp

[Continued to We owe nothing to anybody. Oops ! National Debt!]

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