May 15, 2014: Inflation is one of the perennial pests which eats away the purchasing power of your hard earned dollars. For those of you who are thinking about reaching FIRE need to keep a constant eye on inflation. So the next question is how do you find the current rate of inflation in USA?
Let's take a quick look at the data for inflation (via InflationData.com) for the past couple of years. Studying inflation definitely helps in figuring the rate of growth you need for your investments.
In 2009, the average inflation rate was negative! That actually means that though the U.S. economy was in recession you could buy more with the same dollar than you can now :).
Also, another interesting point to note is that if you opened a 2.00% APY, 12 month Certificate of Deposit (CD) at the beginning of 2009, your money actually earned a rate of 2.00% - (-0.34%) = 2.34% APY!
Now let's check 2013's average inflation rate. It was +1.59%. So if you had opened a 2.00% APY, 12 month CD in Jan 2013, then your money effectively earned a rate of 2.00% - 1.59% = 0.41%!
So a positive rate of inflation in 2013 actually wiped away 2.34% - (0.41)% = 1.93% from your rate of earnings with respect to 2009!
Another question: What APY would you need in 2013 to make your money earn the same effective rate (i.e. with inflation) as 2009?
Let say that the needed APY was x%. That means:
(x - 1.59) = 2.34 => x = 3.93%.
So in 2013 if you were looking to open a 12 month CD, you'd need an APY of 3.93% to keep your money growing at the same rate as in 2009.
Hard luck on that one! So far as our knowledge goes, not one bank offered that high an APY on 12 month CDs in 2013.
So while the economy is in recession it might pay off to lock in good APYs on fixed income instruments like CDs instead of investing in the stock market. But once the economy rebounds then the scenario changes immediately. Now your money will earn less from fixed APY CDs because of positive inflation. Then it might pay off to invest in a disciplined manner in stocks, bonds and ETFs.
What are your views on a negative rate of inflation? Have you used it to your advantage to grow your money?
Let's take a quick look at the data for inflation (via InflationData.com) for the past couple of years. Studying inflation definitely helps in figuring the rate of growth you need for your investments.
| Year | Avg. | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec | |
| 2014 | N/A | 1.58% | 1.13% | 1.51% | 1.95% | |||||||||
| 2013 | 1.59% | 1.59% | 1.98% | 1.47% | 1.06% | 1.36% | 1.75% | 1.96% | 1.52% | 1.18% | 0.96% | 1.24% | 1.50% | |
| 2012 | 2.07% | 2.93% | 2.87% | 2.65% | 2.30% | 1.70% | 1.66% | 1.41% | 1.69% | 1.99% | 2.16% | 1.76% | 1.74% | |
| 2011 | 3.16% | 1.63% | 2.11% | 2.68% | 3.16% | 3.57% | 3.56% | 3.63% | 3.77% | 3.87% | 3.53% | 3.39% | 2.96% | |
| 2010 | 1.64% | 2.63% | 2.14% | 2.31% | 2.24% | 2.02% | 1.05% | 1.24% | 1.15% | 1.14% | 1.17% | 1.14% | 1.50% | |
| 2009 | -0.34% | 0.03% | 0.24% | -0.38% | -0.74% | -1.28% | -1.43% | -2.10% | -1.48% | -1.29% | -0.18% | 1.84% | 2.72% | |
In 2009, the average inflation rate was negative! That actually means that though the U.S. economy was in recession you could buy more with the same dollar than you can now :).
Also, another interesting point to note is that if you opened a 2.00% APY, 12 month Certificate of Deposit (CD) at the beginning of 2009, your money actually earned a rate of 2.00% - (-0.34%) = 2.34% APY!
Now let's check 2013's average inflation rate. It was +1.59%. So if you had opened a 2.00% APY, 12 month CD in Jan 2013, then your money effectively earned a rate of 2.00% - 1.59% = 0.41%! So a positive rate of inflation in 2013 actually wiped away 2.34% - (0.41)% = 1.93% from your rate of earnings with respect to 2009!
Another question: What APY would you need in 2013 to make your money earn the same effective rate (i.e. with inflation) as 2009?
Let say that the needed APY was x%. That means:
(x - 1.59) = 2.34 => x = 3.93%.
So in 2013 if you were looking to open a 12 month CD, you'd need an APY of 3.93% to keep your money growing at the same rate as in 2009.
Hard luck on that one! So far as our knowledge goes, not one bank offered that high an APY on 12 month CDs in 2013.
So while the economy is in recession it might pay off to lock in good APYs on fixed income instruments like CDs instead of investing in the stock market. But once the economy rebounds then the scenario changes immediately. Now your money will earn less from fixed APY CDs because of positive inflation. Then it might pay off to invest in a disciplined manner in stocks, bonds and ETFs.
What are your views on a negative rate of inflation? Have you used it to your advantage to grow your money?
