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Remember Inflation in Investing Projections

Posted By Jim On 12/15/2006 @ 10:24 am In Personal Finance | 6 Comments

Do you ever hear people proclaim that if you invested $100 in the stock market today and it appreciated 11% for the next 30 years, you’d have almost $2,300 at the end? It seems as though people can remember inflation when making short term decisions (such as whether or not to invest in a particular bond or certificate of deposit), but it seems to disappear from the discussion whenever long term decisions are made.

That was the premise of my friend’s article on salary increases, how people tend to forget about inflation when projecting salaries over many years and I think that applies even more so to investing. See, when you invest $100 today and it appreciates 11% to $2,300 in thirty years, you have to keep in mind that $2,300 in 2036 won’t represent the same amount of purchasing power as it does in 2006 – that’s because of inflation. At 4% inflation, your $100 investment is worth around $761 in purchasing power because it really appreciates at 7%, not the full 11%.

I believe that most people (unless you’re a politician, because those guys still don’t have every tax number tied into inflation yet) understand the concept of inflation, the hidden tax, and I hope this just serves as a subtle reminder about its pervasiveness and that you should remember it when you’re doing long term projections (especially if you’re doing long term projections).

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