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What is Inflation? Why does it matter?

Contributed by Ilene Slatko of DSS Consulting

Understanding inflation is a key financial concept. Why? Without taking inflationary pressures into account, your investment returns won’t truly reflect your purchasing power! 

Inflation is commonly used to describe the increase in the absolute cost of goods and services. Another way to say this is inflation reduces what your money can buy. Knowing that, we hope you’ll begin to consider inflation in your financial decisions!

Consider this: the item you paid $250 for last year now costs more than $250. So, you need to earn more than the rate of inflation on your money just to afford the same lifestyle.  And if you want to afford a more lavish lifestyle, you need to out-earn the inflation rate. It’s tricky because it’s difficult to project into the future, but just the realization of how inflation reduces your buying power is a great start!

A gallon of gas, a loaf of bread, a visit to the hospital, the cost of an average home, four years in college. All these goods and services cost more today than in the past, and most likely they cost less today than they will in the future. This is the effect of inflation on purchasing power.

Here is a chart that shows the historical rates of inflation. As you can see, some years it’s low while other years are much higher.

The good thing about investments and financial decisions is that you can make mid-course corrections! The key is not to worry so much about year-to-year fluctuations, but to understand the concept and how inflation erodes your actual rate of return, so you aren’t lulled into “safe” investments that cost you purchasing power. 

In this fun quiz, we’ll go through how inflation impacts your investment returns and your buying power!

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