Inflation – why you get poorer without realizing it.

Inflation – why you get poorer without realizing it.

Imagine you want to buy flowers every week for your loved one and visit her by train. The train ticket costs 10 euro. However in july 2016 the Belgian inflation rose with 2,28%. This means your train ticket is now 12,3 Euro. Life became more expensive or you got poorer. Electricity prices rose 40%, rent prices went up, etc.. Everything became more expensive. As a result, inflation is one of the very few economic indicators that people actually care about since it has a direct impact on their standard of living and personal inflation-adjusted net worth.

See for example the inflation rate for Belgium in 2016 in the graph below (click to enlarge):

See following videos if you still don’t understand..

https://www.youtube.com/watch?v=WKZvm_fqYRM

https://www.youtube.com/watch?v=XwhFAuBSl9g

Why should inflation matter to you?

Even though we can’t predict future inflation levels with certainty, it’s important that you take into consideration both current and future inflation. You have to make sure that you reduce the risks associated with an increase of price levels and that you take advantage of the positive effects of inflation.

First, if you rely on fixed-income or on a paycheck that is not adjusted regularly to inflation, your purchasing power will go down over time and you get poorer without realizing it. Of course, you will hardly feel the effect at first, but over time it will be noticeable. If you have a monthly budget of €1,000 now, you’ll need over €1,200 ten years later to sustain your current lifestyle at a 2% yearly inflation rate. So make sure to ask your company for a regular pay bump. Belgians, rejoice! Our paychecks are automatically adjusted to inflation!

Second, and following the same logic from the previous paragraph, if you are saving up in your (Belgian) savings accounts with an interest rate of 0,11 %, you get poorer as the cash flow from your savings accounts per year is lower than the price increases of the goods and services you need for your life. The cash flow generated by your savings accounts (0,11%) will not cover the price increases of the inflation(2,28%)

Third, if you are in debt the real interest rate will decrease as inflation increases, even though the nominal interest rate remains the same. As a result, you’ll have to pay back less money in real currency. That’s why it currently is such a great time to take out a mortgage in Belgium. When interest rates are at an all time low and once inflation picks up again, your outstanding debt will basically go down to the point where your mortgage was free. This depends whether buying a house is a good investment choice.

Final thoughts

Intelligent readers will have noticed that inflation works almost exactly the same as compounding interest, but in a negative way. That’s why I want to stress that you need to focus on the cash flow generated by your investments.

A clever investor always makes sure that the return on his investments, for example stocks, bonds, rental properties or businesses, is higher than the inflation rate. That’s why I believe dividend investing is the best way to beat inflation when you focus on the cash flow coming in each month or quarter. How do you feel about inflation and which measures have you taken to maintain your purchasing power?