Inflation is a term that we all have heard of but often ignore. It is a persistent increase in the price level of goods and services in an economy over time. Inflation is a common phenomenon that can have a significant effect on our daily lives. Inflation can impact each of us differently, depending on our lifestyle, income, and expenses. One area in which inflation can greatly impact us is our wealth.
When we think about wealth, we tend to think of our bank balance, homes, assets, cars, and other property we own. However, the impact of inflation on these assets is often overlooked. Over time, the value of our money decreases, and our assets become less valuable, which can cause significant harm to our wealth.
The impact of inflation on wealth can be best understood by looking at the time value of money. The time value of money refers to the concept that the value of money changes over time. The same amount of money today will not have the same purchasing power as the same amount of money in the future. This is because of inflation. When the value of money decreases over time, we need more money to purchase the same goods and services we could purchase with less money earlier.
Let’s take an example of how inflation impacts our wealth over time. Suppose you had $100 in the bank in the year 2000, and the inflation rate was 3%. If you left that money untouched for twenty years, it would still be $100, but its value would have decreased significantly. In 2020, you would need $177.25 to purchase the same goods and services that you could buy for $100 in 2000. This means that your wealth has decreased by 44% in twenty years due to inflation.
The impact of inflation on your wealth over time can be even more significant when you factor in the interest rates. If the interest rates are lower than the inflation rate, your savings will lose value over time. The interest you earn on your savings may not be enough to cover the inflation rate.
Inflation can also have an impact on other assets, such as real estate. Suppose you bought a house for $200,000 in 2000, and the inflation rate was 3%. By 2020, the price of the house would have increased to $353,054, assuming an average annual appreciation rate of 3.5%. However, the actual increase in value due to appreciation is $153,054, and the remaining $200,000 was due to inflation. This means that the impact of inflation accounts for more than 50% of the increase in the value of the house.
The impact of inflation on your wealth over time can be significant. It is important to consider the impact of inflation when making financial plans and investments. You should consider investing in inflation-protected bonds, real estate, or other assets that can retain their value over time. You should also make a habit of regularly reviewing and updating your financial plans to account for the impact of inflation. By considering the impact of inflation on your wealth, you can make better financial decisions, which can help you maintain and grow your wealth over time.