What Is Inflation?
“Invest in inflation. It is the only thing going up!”
Will Rogers, the American actor and comedian, might have been joking when he made the above statement, but it undoubtedly reflects economic reality. Inflation is the term used to describe the increase in prices of goods and commodities from year to year. The metric is part and parcel of life as the air above us or the ground beneath us. It is a known fact that Generation Z cannot survive on the salaries their parents made. Just look at how far the housing prices have gone up over the years. In the 1940s, it cost around $3000 to buy a house. This amount increased to approximately $50,000 in the 1980s and $120,000 in the early 2000s. If you want to buy a home in the USA today, it will set you back between $200,000 to a whopping $1 million.
Over time, almost all aspects of the economy have been similarly affected. But it is not all gloom and doom. Economic experts say that some amount of inflation is necessary and even beneficial for the economy. It drives growth, causes wages to increase, and interest rates to fall. If you know how to make it work to your advantage, inflation can be your friend and not your enemy.
How To Calculate Inflation Rate
The inflation rate of an object is the rate at which its price increases over time. It is usually calculated annually and measured in percentage form. An inflation rate of 2% is generally considered a desirable one for an economy.
Here is the formula for calculating inflation rate:
Inflation Rate = ((F – I) / I) x 100
Where:
- F is final amount
- I is initial amount
Example:
Let’s take the example of Product X. Here is how much it cost over three years from 2018 to 2020:
| Year | Cost |
| 2018 | $500 |
| 2019 | $600 |
| 2020 | $700 |
Using the inflation rate formula, we get:
Inflation Rate of Product X over 3 years = ((700 – 500) / 500) x 100 = 27.3%
Inflation And Investing
There is no doubt that inflation and investments share a symbiotic relationship; the value of your investment is tied to the current state of inflation. Depending on the type of investment you have made, this can be a good or a bad thing.
For example, if you have stashed $20,000 under your mattress as part of your retirement savings, the inflation monster will munch away at it, devaluing it over time. So, after five years, even though you have the same amount of money you did before, its purchasing power would have come down dramatically. This reason is why investment gurus never suggest just keeping your savings in a bank. Instead, putting that money into investments that grow at or beyond the rate of inflation is a much better option. These could be long-term stock investments, mutual funds, and commodities such as oil and gold. Another historically inflation-proof investment is real estate, especially the kind from which you can elicit rent. Because rents generally rise along with inflation rates.
How You Can Include Inflation In Financial Planning Calculations – Calculating Future Value
As we have seen, it is essential for investors to not only keep an eye out for inflation but also to include it in their financial planning calculations. One important metric here is Future Value (FV). As its name implies, it is the projected value of an investment in the future. As such, it can help investors and businesses know if it is worth their while investing in a stock or product. What makes it a good bet is that it takes into account the rate of inflation over a set period, giving you an inkling of your investment’s growth value. The only negative is that it does not account for any changes in the inflation rate and instead assumes that it will stay constant throughout.
The FV Formula
The formula to calculate the Future Value of investment is a simple one:
FV = PV x (1 + r) n
Wherein:
- FV denotes Future Value
- PV denotes Present Value
- r denotes rate of inflation
- n denotes number of years
Example:
Supposing you want to invest $10,000 into a mutual fund that matures in 10 years. Let’s find out what the future value of the investment will be with an inflation rate of 5% by applying the FV formula:
FV = 10,000 x (1 + 5) 10 = $16,289
With an inflation rate of 5%, your initial investment of $10,000 will grow to $16,289 in 10 years. With this data in hand, you can now decide if this is the kind of growth you want your investment to achieve or not.
How To Use Our Inflation Rate/Future Value Calculator
If thinking about doing the above mathematical calculations makes you break out into a cold sweat, we have just the solution for you. You can use our easy-to-use inflation rate calculator instead, and it will do all the hard work for you. Input the Present Value of your investment, the inflation rate, and how many years into the future you want to see. Then hit calculate and sit back. You will have your Future Value calculations soon, all in the space of a few seconds. For other similar calculators, including a nifty one that calculates the future value of money.
Conclusion
Like it or not, inflation is an inevitable part of our lives. While you cannot predict how far up and down it can go, you can safeguard your savings and maybe even profit from it. For that, it is essential that you consider this crucial metric when planning your investments.