Financial Foundations: Inflation
Hi! I’m Nick, and welcome to Financial Foundations. I’m going to cover several concepts of investing that may seem confusing and show you that they’re actually simpler than you think. Let’s talk about inflation.
So, what is inflation? Well, inflation is the rising cost of everyday things you buy and services you use. It’s also known as a decrease in your purchasing power. Let’s look at an example to get a better understanding.
Let’s say that today you go to the store and buy a brand new cellphone for $100. Now let’s say that that cell phone brakes exactly a year from now and so you go back to that exact same store and buy that exact same cellphone. The only difference is that the cellphone costs $103 as supposed to just $100.
The reason the cellphone is priced higher is because the cost to make the cellphone has gone up over the past year. That’s inflation!
Let’s assume that inflation averages 3% per year. So this means that you can expect an item or service to cost 3% more next year than it did this year. And this continues on year after year. So, as prices rise, purchasing power decreases. Wait, what is purchasing power then? Well, purchasing power is the value of a certain amount of money. So, as the cost of goods and services go up, the value of a dollar decreases.
$1 this year is worth less than $1 last year, and a dollar’s purchasing power decreases as the years progress. For example, at a 3% inflation rate, $100 today will only be worth $97 next year, and this pattern continues on year after year. So, why do you need to know this? Well, inflation is an important thing to take into account when you’re planning to save for something in the future, whether that be a new car, your wedding, or retirement. So, if you want to buy that new car that you currently have your eye on in 5 years and it currently costs $20,000, you’re going to need to determine how much will cost in 5 years because of inflation and then save or invest accordingly. So, at a 3% inflation rate that car in 5 years will roughly cost $23,200. There’s inflation for you! And there are many more seemingly confusing concepts that are much simpler than you actually think. I’m Nick, thanks for joining me on Financial Foundations, and I’ll see you next time!