First Person: The Benefits of Understanding Inflation

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The US Bureau of Labor Statistics is putting the 2012 average inflation rate right around 2 percent. There are those out there who will write about the dangers of inflation, and in a way, I'm one of them. Sure, inflation can be a real financial danger should it get out of control or when it starts to negatively affect our personal finances. However, by understanding inflation, I can begin to harness its affects and at times utilize it to my advantage. And even if there are times during which I can't make inflation beneficial to our personal financial situation, I can at least utilize my understanding of it to minimize it's affects on our money and buying power.

Evaluating Our Retirement Future

Inflation is one of those things that on a monthly or annual basis might seem somewhat insignificant, but when I'm looking at retirement projections in 20, 30, or 40 year's time, it could make a substantial impact upon how I plan.

Not too long ago, I wrote an article that discussed our family's personal rate of inflation, which I find much more pertinent to our situation than the federal government's estimates of inflation. While we tend to keep our costs quite low, I did some rough calculations to find that based upon our expenditures over the years, our personal inflation rate falls somewhere around 3 percent. Using this level of cost increase over the next 35 years or so, I realized that if things stay on track, we could easily be paying in excess of $70,000 a year in retirement for the same or similar costs that we're experiencing now. It was a somewhat sobering realization to say the least.

Better Budgeting

If I know that our inflation rate is going to be somewhere around 3 percent this year, and I use that as a benchmark for next year, it can help me better develop my upcoming budget. Let's say for example that our annual costs are right around $30,000 a year. Well, knowing that inflation could push those costs up by three percent next year, then I might need to budget another $1,000 over the course of the next year or about $83 a month to cover costs.

Doing COLAs

As a self-employed individual, I don't get an annual review or cost of living adjustment (COLA) from my employer unless I do it myself. Some employers tend to base their employee raises on what the average cost of living is increase has been. Since in some cases, I must determine and set my own pricing with customers, it helps me to stay competitive and yet maintain wage stability to be able to determine inflation and adjust my pricing accordingly to keep pace with the increased cost of living.

Determining Investment Performance

Understanding and watching inflation helps me gauge various investments and investment opportunities. Let's take for example the certificate of deposit my wife and I had recently. The CD was earning about 1.7 percent. Inflation was about the same rate, so really, we were just breaking even on our money. However, we were looking to buy a home at the time as well. Mortgage rates were at around 4 to 4.5 percent. Rather than maintain an even money situation on our CD, it was more beneficial to us to cash the CD in, taking the 3-month interest penalty in the process. This helped us minimize the higher mortgage rate, which in essence saved us about 2 to 2.5 percent on our cash not to mention eliminated the costs of obtaining a mortgage in the first place, which could have added $1,000 or more to the costs of buying our home.

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