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Explain How Inflation Impacts Your Investments

Inflation is an increase in the volume of available money in relation to the volume of available goods and services; inflation results in a continual rise in the price of various goods and services. In other words, because of increased inflation, your money can buy fewer goods and services today than it could have bought in the past.

Inflation negatively impacts your investments. Although the amount you are saving now will be the same amount in the future, you will not be able to buy as much with that money in the future (in other words, the purchasing power of your money erodes). Inflation makes it necessary to save more because your dollars will be worth less in the future.

Problem 1: Inflation

Forty years ago, gum was five cents a pack. Today it is thirty-five cents a pack. Assume that the increase in the price of gum is totally related to inflation and not other factors. At what rate has inflation increased over the last forty years?

Before solving this problem, clear your calculator's memory and set your calculator to one (for an annual payment). Then input the following information to solve this problem:

  • PV = –$0.05
  • FV = $0.35
  • N = 40
  • I = ?

On average, inflation has risen by 4.99 percent each year for the last forty years. So, the average price of gum has increased by 4.99 percent each year for the last forty years.

Problem 2: Inflation—The Future Value of a Wedding

I have six wonderful daughters and one wonderful son.  It is estimated that an average wedding cost $23,000. Assuming 4 percent inflation, what would it cost me to pay for all six of my daughters' weddings in fifteen years? (I hope this won't happen—at least not all in the same year)

Before you begin, clear your calculator's memory and set your calculator to one annual payment. Input the following information to solve for the cost of a single wedding in fifteen years:

  • PV = $23,000 (Assume that on average a wedding still costs $23,000)
  • N = 15 (The cost will increase every year for fifteen years)
  • N = 4 (The inflation rate is 4 percent)
  • FV = ?

In fifteen years, the value of a single wedding will be $41,422. This means six weddings will cost $248,530. Inflation will raise my costs by 80 percent (($41,422/23,000) –1), so I need to plan now.


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