This is part II of a III (that is 2 of 3) part series. If you have not read part 1, you can do so here.
OK, Question 2!
Imagine that the interest rate on your savings account was 1% per year and the inflation rate was 2% per year. After one year, how much would you be able to buy with the money in this account?
A. More than today
B. Exactly the same
C. Less than today
From the last question, we know that $100 at 1% is $101 (100 x .01). Cool. That was the easy part.
A few words on inflation:
I am 43 years old. That’s inflation. Just kidding. LOL. I am 43 years old and and I remember when a Hershey’s chocolate bar cost $0.25. Today, in 2015, the average price is $1.19. This is an increase of 476% in let’s say, 35 years. It could have been more or less in some years, but in 1978 a chocolate bar cost .25 and in 2015 it cost $1.19. This is inflation.
How is inflation measured (i.e. the question we are attempting to answer tells us that inflation is 2% per year.)
It’s based on a basket of goods that someone in the Government has decided is somewhat applicable to most of us. It changes every year based on trends (i.e. subscription to cable T.V. gets bumped; iPad makes it’s grand entrance!). It is also seasonally adjusted, to account for the fact that many of us spend much more on heating costs in the Winter. Stuff like that.
I am sure it is all quite scientific and that the mere existence of the CPI (did I mention that is what it’s called? The Consumer Price Index) keeps hundreds, if not thousands, of civil servants employed all over the world. But there is stuff in that basket that doesn’t super apply to me (baby wipes, cereal, every book in the Twilight series (( not making that up!)), etc.).
I am going to make my own. Because it’s my blog and so I can do stuff like that.
The official (you read it here first!) MONEY COACH CPI!
| Item | 2015 | 2016 |
|---|---|---|
| MAC Lipstick | $17.50 | $18.75 |
| Coach Bag | $290.00 | $310 |
| Starbuck's Latte | $4.5 | $4.75 |
| One-dozen Omega-3 Eggs | $3.95 | $4.05 |
| Wheat SourDough Bread | $3.85 | $3.95 |
| Bunch Organic Kale | $1.80 | $1.85 |
| 3-Pack Moleskin Writing Notebooks | $16.50 | $17.00 |
| Monthly YMCA Membership | $54.00 | $58.00 |
| Gas for Ford Explorer | $90 | $70.00 |
| Monthly iPhone Bill | $79 | $69 |
| Adidas Running Shoes | $120 | $125.00 |
| 750ml Shiraz Cab | $18.00 | $18.00 |
| $603.00 | $621.35 |
All right. What can we glean from the above? Most things go up (lipstick, wine, food), but a few things go down (technology tends to get cheaper: think how flat screen T.V.s in 2016 are a fraction of what they were in 2006). And some things stay the same (for awhile anyway).
What else? Yes, you are right! Inflation (according to the Money Coach CPI) in 2016 is 1.03% (621.35 / 603.50 x 100 = 1.029)
And with that, I think we have enough information to answer our question: Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account?
Let’s go back to our $100.
If we earn 1%, we have: $101 (100 x .01 = 101)
If inflation is 2%, a basket of goods that cost $100 today, will cost $102 next year.
We will have $101.
We will need $102.
Ah, crap. (The answer is C. We can buy less than we could today)
I don’t know about you, but I’m losing the kale!
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I'm Nanci Murdock. I am a Montreal based money coach who helps women who want to learn how to invest on their own but might not know where to start.
