If you drive a car or eat food you’ve noticed prices tend to rise more than fall. Paying for childcare, healthcare, or college tuition has been a challenge as the rate of inflation for these items has soared. College tuition, for example, has increased 197% since 1996![1]
Inflation is a metric not often tracked by investors. The stock market gets all the attention, but inflation may have more of an impact on your long-term wealth, especially if your assets aren’t invested properly. It can wipe out a generation of hard work without warning.
Inflation is defined as the rate at which prices increase. The Consumer Price Index (CPI) is how the United States measures inflation. From 1926 to 2015 it averaged 2.9%. However, there have been a few times when it spiked. From 1917 to 1920 it averaged 16.4% per year and from 1970 to 1982 it averaged 7.7% annually. Prices will double every 24 years at the historical rate. Today, a Tesla Model X costs $80,700; in 50 years it will cost $353,781 if inflation averages 3%.
Another way to look at inflation is the loss of purchasing power. At a 3% inflation rate the value of the dollar will drop by 58% over 30 years, a dollar today will be worth 41 cents in the year 2048. In 1975 it was possible to purchase 10 stamps for a dollar; today it will only buy two!
Hyperinflation occurs when inflation spirals out of control. The Weimer Republic of Germany experienced a bout of hyperinflation from 1918 to 1924. It peaked in November of 1923 when inflation climbed 29,525%! Venezuela is currently ensnared by hyperinflation as prices have increased 4,000%.[2] Hyperinflation has primarily been limited to developing countries like Venezuela, Vietnam, Iraq and Zimbabwe. Countries can also experience hyperinflation during times of war like the United States did during the Civil War.
However, a low rate of inflation is healthy for our economy if it can be contained to 1% to 3%. Companies will benefit from rising prices as the increase can flow to their bottom line in the form of higher earnings.
Investors who rely on fixed income investments like bonds or certificates of deposit will see the value of their investments eroded by inflation as evident in the chart below. A $1 investment in bonds was worth $21 after 90 years. After inflation, it dropped to $7. Stocks, on the other hand, have benefited from inflation. A $1 investment in small stocks grew to $22,985! 
Your retirement may last 30 years or more so it’s imperative to allocate a healthy portion of your assets to stocks. Resist the urge to retire your money as well. A portfolio of “safe” investments may leave you in dire straights toward the end of your retirement.
Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man. ~ Ronald Reagan
Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX. For more information please visit www.parrottwealth.com.
3/1/2018
Note: Past performance is not a guarantee of future returns. Your returns may differ than those posted in this blog and investments aren’t guaranteed.
[1] https://www.financialsamurai.com/the-inflation-interest-rate-paradox/, Posted by Financial Samurai, website accessed 3/7/2018.
[2] https://www.bloomberg.com/view/articles/2017-12-19/venezuela-is-living-a-hyperinflation-nightmare, by Noah Smith, December 19, 2017.