Inflation is a term that is often thrown at our faces especially, post-pandemic. It has got everybody worried about their finances including investors, businessmen, and especially salaried-class individuals, for the right reasons.
Inflation plays a key part in our everyday life. It determines the purchasing power of an individual or company and also the evaluation of assets.
Having access to a future inflation calculator can help predict the future value of the currency which assists in making a variety of financial decisions.
What Is Inflation?
Inflation is essentially the devaluation of money. It inversely affects the purchasing power which means while you have the same income, you would not be able to purchase the same amount of goods.
It is different from the day-to-day fluctuation in the price of goods because in that case prices rise and then come back again.
Whereas with inflation, there is a broad increase in the prices of items, which is generally irreversible. Prices of utilities like electricity and gas are given more importance while calculating inflation.
How To Calculate Inflation Rate?
The country-wide inflation rates are often quoted and discussed on national television but they are not necessarily in line with personal inflation rates.
You need to calculate personal inflation rates to plan the budget and savings for the next few years to avoid financial troubles. There are several ways to calculate it but the simplest of the methods has the following steps:
- Divide your spending into categories such as energy, housing, food, entertainment, and clothing. You may have to contact the bank for the credit card statement to know exactly how much is being spent in each category.
- Find out the share of each category in the total expenditures. You can divide the amount of each category by the total expenditure to know the share of each bucket.
- The US Bureau of Labor Statistics issues a routine update on the inflation of each category in the Consumer Price Index or CPI. Correspond the share of each bucket with the list and adjust it for inflation. The list will show the annual increase in the price of each category. You can get the personal inflation rate of each category by multiplying the annual percentage rate with the share of that particular category.
- Now add the individualized inflation rates of each category to get a total personal inflation rate. Compare it with the national inflation rate to know whether the inflation has affected you the same as most residents or more.
For those who do not want to rely on CPI to calculate Inflation, the following formula can be used.
Inflation = (Final Price / Initial Price) ^ (1 / time that has elapsed in years)
You can use Omni Calculator, a free online tool, to calculate inflation if the described process seems complicated.
Financial Context For Inflation?
Most people keep money in the bank or invest it somewhere. Saving accounts provide an incentive of interest which means the bank adds a certain amount to our savings every year.
Let’s say the amount in the savings account is $1,000 and the interest rate is 5%, the bank will add $50 every year. Now if the inflation rates correspond with the interest rates, the account holders neither earn much profit nor incur any loss.
But if the inflation increases by 10%, which the US is very close to hitting since 1982, and the interest rate remains at 5%, it means that the amount in your account has lost its value, and cannot purchase the same items anymore as it could have in the previous year.
The 10% inflation means that the purchasing power of your money has depreciated by 10%. Thus, now the $1,000 in the account will have a spending power of $900.
Inflation can work in your favor if your investment portfolio consists mainly of physical assets like gold and real estate. In addition to that, if you can predict that there is going to be an increase in the price of edible commodities, you can buy those and then sell them later as inflation goes up.
Moreover, you can also save yourself from the effects of higher inflation by keeping your savings with banks or credit unions that offer higher interest rates.
As a general role of thumb, higher inflation means higher interest rates. By this, governments try to drain money from consumers by tempting them to save rather than spend it.
How To Calculate Future Cost With Inflation?
Actual inflation can be different from the estimated figures but the latter can be quite helpful in figuring out the future costs of products and hence planning the budget accordingly.
The predicted rates are published for different spending categories. You can multiply the inflation rate by the expenditure of a particular category to estimate future costs.
Hyperinflation?
Hyperinflation is a term devised for situations when inflation rates exceed 50%. It typically happens when the government prints a large amount of new paper money. Hence, the money loses its value which produces a massive rise in inflation.
The inflation experienced by Germany post-WWI is the classic and most quoted example of Hyperinflation.
The Impact Of Inflation On Investors?
As mentioned earlier, higher Inflation means higher interest rates and that means people are reluctant to borrow money from banks to invest. Thus higher inflation generally has detrimental consequences for investors, especially stock investors.
Investors do not just have to incur losses in the investments but also pay more in debts. In addition to affecting stocks, inflation also negatively impacts fixed-income investments such as municipal bonds and treasuries.
The interest on these investments generates a stable source of income but the problem is the interest rate remains stable until the maturity of the investment. Hence, when inflation increases it declines the purchasing power of the income that is being generated by the fixed income.
This is in contrast to investments in real estate because they have a positive relationship with inflation. It is probably because the price of real assets is the indicator of inflation.
The increase in prices of such assets increases inflation which means the owners essentially experience appreciation in the value of their assets. It is exactly why real estate has been the go-to investment for investors in rising inflation.
Energy-related commodities, particularly oil, also have a similar relationship with inflation. But the downside to owning these assets is that they do not offer a stable and consistent stream of income.
