Saturday, August 30, 2008

Why one million dollars just isn't worth what it used to be

Forty years ago, if you had one million dollars, you had it made.  While one millions dollars is still a huge some of money, being a millionaire just isn't what it used to be.  Either you are old enough to remember when bread, candy bars, and soda cost a nickel or have have heard your elders lament how expensive everything is these days.

The slow (or sometimes quick) rise of prices over time is caused by inflation.  Most researches agree that over the past 93 years in the United States the price of goods and services has risen by an average of approximately 3.5% every year.  According to this great inflation calculator on coinnews.net, an item that cost $20 in 1968 would cost $126 today!

Inflation is easy to measure for some goods, such as ground beef.  One pound of ground beef purchased today is going to be just about the same thing as a pound of ground beef purchased 50 years ago and will probably be the same in another fifty years.  Because of this, it is easy to measure price inflation for ground beef.  But how do you measure the inflation rate of computers?  A laptop computer today might cost, on average, $1500.  Ten years ago, you could also get a laptop for about the same price.  However, the one you buy today is a much different, much faster, much better product.  Because of factors like this, overall inflation is very difficult to measure and many researchers disagree about the rate of inflation that the U.S. has experienced over time.  If they don't agree on the historical rate, you'd better believe that there is no consensus on prediction for the future rate of inflation.

What does this mean for you?  It means that when you are planning for the future, you better make sure that you take inflation into account - you don't want to plan $20 for an expense that will actually cost you $126.  Even though you don't know what the rate of inflation will be, you can be certain that you will experience the effects of inflation to some degree.

Because people are living longer and retiring earlier, inflation is becoming an increasingly significant factor in retirement.   If you retire at age fifty and live to age 90, your retirement will cover a span of 40 years.

Investments with a fixed rate of return - savings accounts, CDs, and most bonds - can be great investments, but offer you no real protection from inflation.  In fact, many bank savings accounts pay such low interest rates that, depending on the rate of inflation, your account might actually be losing value even as you collect interest.

However, investments such as stocks, mutual funds that invest in stocks, and TIPS (Treasury Inflation Protected Securities - a savings bond that pays a base rate plus the current rate of inflation) all tend to grow faster than inflation.  If you are planning for a long term financial goal, you need to include investments like these in your portfolio.

One million dollars isn't what it used to be.  In fact, to have the same buying power as a 1968 millionaire, today you would need more than 6.3 million dollars.

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