Why I Don’t Care About Inflation

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In my post Growing Your Tax Refund much earlier in the year, an anonymous commenter noted that I didn’t account for inflation in my comparisons. I bring this up again (this has been brewing in the drafts for quite some time) because with the Federal Reserve opening the spigots with QE2, a lot of people are thinking about how inflation might be affecting them. In my post, I compared how your average tax refund could be increased based on what you did with the money (other than spending it).

An anonymous reader noted that I ignored inflation in my comparisons (it wasn’t relevant as I was comparing several options against one another), but in general I’m not terribly concerned with inflation. In fact, I can safely say that I honestly don’t care about inflation because:

  • I can’t control it.
  • It affects everything equally.

By definition, inflation is the change in your money’s purchasing power, specifically the decrease in your money’s purchasing power. It’s why $100 in 1980 is worth $264.12 (BLS’s inflation calculator) and why a million bucks fifty years ago (1960) needs to be more like $7.3 million today.

While it’s important to remember that inflation exists, there really isn’t anything you can do about it. You save money in a certificate of deposit, despite its interest rate being under the historic inflation rate, because it’s better than zero. The best CD rates for a 1 year CD are less than 1.50% APY. I’m pretty sure, and we can confirm with by looking at CPI figures, that inflation was higher than 1.50% but that doesn’t matter. A 0% checking account lost even more.

What you should actually do is compare your investment with a “safe” investment over that same time period and decide whether the added risk is worth it. When companies or individuals invest capital, it’s always with an eye towards the “safe rate of return.” The rate you get above that is a risk premium. The rate of inflation is almost irrelevant.

When you choose where to invest, the investment matters as much as how it fits in your overall plan. The stock market might beat inflation but any financial expert will warn that if you need your money in the next 3-5 years, don’t put it in the stock market. The market can go up as quickly as it can go down and that higher rate of appreciation (risk premiuM) comes at a cost.

It’s important to consider inflation when building your overall financial plan, but it’s not a consideration for every single investment. Your overall plan needs to beat inflation but not ever investment needs to overcome that hurdle. So, the next time someone throws around the idea that you need to worry about inflation or you need to beat inflation, think about how much it really matters and when.

What do you think? Am I completely wrong (yes, it’s happened! ask my lovely wife!) and how do you think of inflation?

{ 18 comments, please add your thoughts now! }

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18 Responses to “Why I Don’t Care About Inflation”

  1. DIY Investor says:

    In teaching macroeconomics today inflation is one of the most difficult topics to get across simply because young people haven’t experienced inflation. In the early ’80s this wasn’t the case because inflation was in the double digits and inflation was the #1 problem in the country. Students were interested in what caused it, what policies were available to combat it and how could it be that its ugly cousin stagflation could cause unemployment to rise even as inflation was accelerating.
    At that time your headline would have been equivalent to writing today that you don’t care about the federal deficit or the national debt.
    Today, in the investment world, it is very easy to stay ahead of inflation. That won’t be true in the future with the Fed policies now in place. Relax now, there will be plenty to worry about down the world.

  2. zapeta says:

    I don’t worry about inflation either. I just stick with my investment plan and I should be able to stay ahead of inflation.

  3. Shirley says:

    My investments are sound enough to be in my ‘comfort zone’. There’s not another thing that I can do concerning inflation and nothing positive will come out of worrying about it.

  4. ZB says:

    There are things you can do about inflation. First and foremost, make sure your mortgage is a fixed-rate loan.
    It will be much easier to pay off that note with debased dollars than with today’s dollars.

    Beyond this, the Treasury sells what they call TIPS (Treasury Inflation Protected Securities) which scale their returns to the published inflation rate.

    Going yet farther into the rabbit hole, you can invest in ETFs like GLD and SLV (among many possible options) to keep some of your nest egg based on commodity prices; these issues will tend to rise with (or even beat) inflation as investors seek to avoid the degradation of their wealth.

    A step beyond that is to own your own small cache of gold and/or silver – be that in jewelry or coin form.

    Again, as inflation eats your paycheck, the value of these items in nominal dollars will rise, making it easier to make payments on fixed-interest debt; I’ve heard it said that an ounce of gold was enough in Rome to buy a nice suit (toga) and a sword, and it’s still just about that valuable today.

    The downside is that you’re not earning interest on physical holdings and commodity plays. In reality, you’re not even really getting ahead… you’re treading water while someone has pulled the plug on the pool, which means your wealth is just sinking slower than everyone else’s.

    That’s why anyone sane recommends that you don’t go overboard on your positions, but rather make them a balanced portion of your overall investment portfolio. After all, stocks will generally tend to rise with inflation as more money chases a static pool of investments.

    • cubiclegeoff says:

      Can’t forget that holding commodity ETFs can require paying taxes on your holdings every year, decreasing its value. Plus finding a place to get gold and silver at the right price, and finding a place to sell it at a decent price may be more expensive than its worth.

  5. Jim,

    Assume you buy a CD today and by the time it matures, the dollars you collect buy less than today’s dollars buy.

    In other words, the interest earned is not good enough to compensate for the lost buying power. In that case, doesn’t it make sense to spend now – and not bother to save?

    Inflation does matter.

    • Jim says:

      It only makes sense to spend it now if there’s something I want to buy. You lose all of the purchasing power of a dollar once you spend it.

  6. Hannah says:

    I agree that when comparing the returns of CD/Treasury/Stocks there’s not really a point of factoring in inflation. However, it’s a little over the top to say you don’t care about inflation at all.

    Our grandparents pay more for a new car today than they paid for their first homes. Obviously if they started saving for retirement at the same time, and assumed that the dollar would buy them the same amount of goods in 50 years, they would be in trouble today.

    • Shirley says:

      While your statement is absolutely true, if savings are calculated by a % of wages, rather than a set dollar amount, it works out surprisingly well. 15% of my wages went into a 401k and the monthly disbursements from that now are more than I was bringing home at the time that decision was made.

      Yes, what I paid for my first home would probably buy only a used vehicle today. 😉

  7. RJ Weiss says:

    The only time one should care about inflation is once they are close to retirement and planning their withdrawals.The difference between a 3 and 4% inflation adjustment is huge.

    Your right, inflation is out of your control. All you need to do is acknowledge that it exists.

  8. Mike says:

    I think the assumption that inflation affects everything equally is inherently flawed. If it applied equally, then those cards my insurance agent send on my birthday comparing the cost of living now to when I was born would be less interesting. Some of the items show great increases (as a percentage) in price (homes, cars) but others show smaller changes (bread, eggs, milk).

    Cars are actually cheaper today than they were when my grandparents bought their first car. How do I make such a bold statement? Easy. Today’s cars have so many advanced features from automatic transmissions, radios, wipers, lighted signals, internal diagnostic/monitoring computers, etc, etc. That means that while the price is higher, you get more for your money. While my statement may be exagerating that they’re cheaper, it is not as much as home price inflation.

    I do agree with your basic statement that you can ignore inflation and make the best investment choices available at the time.

    In 2006 and 2007, everyone thought oil would break $200/brl and everything would grow at 10%/year like it had been. Now look at it and we’ve actually seen some things remain constant or deflate.

  9. anom says:

    Inflation is running at 0.6% right now.

    • uclalien says:

      Yes. If you ignore two of the most basic necessities of 21st century life, core CPI (not necessarily inflation) is 0.6%.

      But if you research how CPI is calculated, there are simply too many arbitrary choices made in the methodology to assume the calculation is meaningful in any way. For instance, rather than use a more accurate value for the cost of housing, owner’s equivalent rent (OER) is used. The following graph shows just how inaccurate OER measure is:

      To summarize, CPI grossly underestimated housing price inflation during the bubble and is now grossly underestimating housing price deflation.

      OER is simply one of CPI’s many flaws. Others include: CPI’s failure to adjust for improvements in quality, how price increases are determined for new products, how the government has changed CPI’s methodology to manipulate the results, CPI as a lagging indicator of inflation, any many others.

      In my opinion, CPI is simply too unreliable to be a good measure of inflation.

  10. billsnider says:

    interesting thing about inflation numbers is that it does not cover the whole spectrum. For example – tax rates and goverment fees to name two. The real inflation rate is higher than you think.

    To those of you who were not out there in the 70’s supporting a family, inflation is a tough road. My real estate taxes went up better than 10% per year for several years. Coffee prices seemed to go up daily. A gallon of gas was $o.37 (believe it or not). It shot up to $0.80 seemilngly overnight. It changed everything that was going on.

    Bill snider

    • Shirley says:

      LOL… I was there and I do remember those days!
      I have to say that life now seems much more stable and that the “good old days” were fun, but not really all that good.

  11. Roommate says:

    In 2001 gold cost around $280 per ounce, so if you bought a 100 ounce gold bar for $28,000 then that Same gold bar would be worth over $130,000 now.

    It’s better to keep most of ur wealth in your home(paying it off) than to keep it in cash in the bank which depreciates over 4 percent a year indicated by gold.

  12. cubiclegeoff says:

    I think about inflation on in that I try to have my money make more than inflation, and when I buy something, I like 0% financing deals knowing that inflation will probably make it more worth it in the long run. Other than that, I’m more concerned about stagnant wages over the past 3 decades.

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