Friends Don’t Let Friends Ignore Inflation

Lets say you have two friends. One of your friends keeps stealing money from the other. Wouldn’t you feel an obligation to warn your one friend about the other? Of course you would! It’s the same obligation I feel when I think about your money and inflation. There’s an invisible creature among us that continues to diminish our hard-earned dollars, but for whatever reason many people continue to ignore it.

A Riddle For You 

Take the two friends we created above and lets add a third: Adam, Christina and Ceelo (I promise these names are completely random; I’m not watching The Voice). Adam, Christina, and Ceelo each purchased a home for $1,000,000 in three successive years and then decided to sell the home one year later.

  • During the year of Adam’s ownership, the country experienced a period of 10% deflation. A year after the initial purchase, Adam sold his home for $920,000.
  • During the year of Christina’s ownership, the country experienced a period of 10% inflation. A year after the initial purchase, Christina sold her home for $1,080,000.
  • During the year of Ceelo’s ownership, the cost of living stayed pretty much the same and she sold her home for $980,000.

The Million Dollar Question

Who fared the best?

Most people would see the $80,000 gain for Christina and immediately think she came out on top. Most people will also see Adam’s $80,000 loss and immediately think he fared the worst. It’s understandable to think this way, but it’s completely wrong.

Adam is actually the only homeowner to make money. During a a period of 10% deflation, Adam increased his purchasing power by 2%  while Christina and Ceelo each settled for a 2% loss.

Why This Is Dangerous

According to Economist Richard Thaler:

A person who invests $10,000 today in the stock market will have about $67,000 in twenty years, assuming a 10% average annual return, whereas a person who invests $10,000 in U.S. Treasury bonds earning 6% a year will have about $32,000.

Now lets account for inflation:

Assuming average annual price hikes of 4%, the stock investor would have the equivalent of $32,000 in today’s buying power after two decades had passed while the bond investor would have less than $15,000.

This is the exact reason why I laugh at those “investing” all of their money in CDs. Ignoring inflation could be a greater risk than stomaching the swings in the stock market.

Will you do me a favor and promise not to let your friends ignore inflation?

Written by A Blinkin

A Blinkin

Hunter, aka A. Blinkin, is the blogger behind Funancials. His experience in banking, lending, payments and investments has earned him the title of “Personal Finance Guru.” In addition to helping people with their finances, Hunter enjoys crunchy tacos, spending time with his wife and puppy, and writing in third person.

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  1. says

    Yes inflation is a scary beast that cannot be ignored. This is all assuming that inflation carries on at its current pace. What about when shit hits the fan and inflation skyrockets? Then you better hope you had invested in something that had value increasing at least at the same rate as inflation.

    • Anonymous says

      True but it could be a positive thing as well. 3-4% or any small number is easy to ignore but maybe conservative folk will finally feel the need to act differently when the number is much higher?

      • says

        I agree that there are positives to bad times. People do learn to adapt and become stronger for it. It’s just a shame that many people may have to lose a bunch of value from their money to learn that lesson.

  2. Maria@moneyprinciple says

    Ha! I did manage to work this one out – I have learned a lot in these two years :). Now more seriously:

    What you say is true statistically and in general. I have a problem with both statistics and generalities – these tell us very little about individuals and cases. Inflation is a horrid thing but it is worked out by a basket including many items that don;t need to be purchased often. How individuals fare during perionds of inflation is a very interesting question and the answer is a matter of ingenuity, flexibility and adaptation rather than economics.

    Having said all this, I am determined to stop being such a girl and start investing in shares rather than saving or buying CDs (which is basically saving anyway).

  3. says

    A close second to inflation would be fees. Tack on a 1.5% management fee to your 4% inflation and wealth creation becomes a near myth.


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