Inflation: A Threat to Purchasing Power
Inflation, in a general context is inversely related to purchasing power and directly comparative to cost of living. As inflation rate increases, purchasing power of money decreases and cost of living increases. The value of money reduces with inflation. Your $100 today cannot purchase the same item over time. How does inflation affect purchasing power? Does inflation affect your $100 saving in the bank? Is the interest rate earned from your $100 savings higher than the inflation rate? Assuming regular inflation rate is constant per year between 2 to 3% and the interest income gained from your savings is slightly lower than the inflation rate, then you should have placed your money in investment securities that will produce higher earnings than inflation. Although, there are various preferences when it comes to investments like stocks, mutual funds, and trust funds that can produce higher return compared to the inflation rate, the assumption of higher risks may be involved as stock market prices fluctuate even without anticipated inflation.
Investments in real estate can protect your money from depletion since these assets usually appreciate. Passive income with monthly cash flow is a good contributor to cope up with inflation especially if it is controllable. Rental income from real estate can be controlled against inflation. The lessor has the option to increase its monthly rental to manage his purchasing power. Cash dividends can be invested back to earn more. This can also be done for the incremental cash income generated from intangibles like royalty and patent and will surely help manage inflation.
In most cases, inflation may imply that the economy you are in is growing and the country needs to adapt to the inflation declared by the government to survive with the global economy as well. The more the economy adapts to the rising general prices for goods and services, the tremendous result of inflation will greatly affect the purchasing power of the unemployed, fixed-income retirees, and fixed-income contractors. If salary income for employees remains constant for a specified period of time, purchasing power will become weakened. The poor becomes poorer. The middle class will remain struggling to cope up with cost of living and lifestyle. The rich will become richer because they continue to raise prices to cover up the rising expenses and to achieve the targeted profit margins for the year.
However, even if the government has already confirmed the inflation rate for the year, the purchasing power of an individual will definitely depend upon his own personal inflation rate. His purchasing power is entirely dependent on his lifestyle and spending habits. Even if his income increases constantly, it will not be a big deal if expenses are higher than the increase.
The impact of inflation will not be felt by an individual if he can manage his finances especially his expenses well. His purchasing power will not be sacrificed if he has incremental income higher than inflation. Inflation rate therefore should not be a threat but rather a person’s basis for his marginal rate of return.