How Inflation Affects Your Financial Future
Learn how inflation affects your financial future by testing your own investments so you can see whether you are gaining or losing.
What does TB × IF = TRV mean?
We’ll show you below as you read this short post.
Most investors completely neglect inflation, not realizing that what they think are gains turn out to be losses due to the depreciating dollar.
And if you continue to put your hard-earned savings into investments that are losing you money, what kind of financial future do you think you’ll have?
So don’t underestimate the importance of how inflation affects your financial future.
Inflation Has Created an Investment Illusion
Real inflation over the last 15 years has devalued the dollar by 74%.
And the stock market hasn’t fared well at all when measured in real dollars.
The S&P 500 has actually fallen by 63% since 1999.
Record highs are just fueled by the Fed’s policy to devalue our currency, which makes everything more expensive.
… including stocks, bonds, mutual funds and any other paper asset measured in dollars.
Most financial planners miss this.
Don’t do it. Your lifestyle depends on how inflation affects your financial future, so take it seriously.
If you dare, test your own investment strategy to see how well it has held up under the Fed’s inflation.
You will probably be very disappointed.
But the good news is you can do something about it.
The first step in fixing the problem is to understand it.
Test Your Own Investments So You Can See How Inflation Affects Your Financial Future
So let’s get started so you can learn how inflation affects your financial future.
The following chart shows how much the dollar has depreciated over various lengths of time.
To be accurate the chart should only be used for periods ending in mid-2014, though it will give you a rough estimate until the inflation rate changes significantly.
To use the chart, just take today’s investment balance from your latest portfolio statement, take the number of years you’ve owned the investments that make up your balance and find the Inflation Factor in the chart.
The chart lists John Williams’ Shadow Government Statistics Alternate CPI Inflation factor, which is a more realistic indicator of real inflation.
The chart also lists the “official” Bureau of Labor Statistics CPI-U Inflation Factor, which is understated.
We recommend that you use the ShadowStats Alternate CPI Inflation Factor in the middle column.
The “Inflation Factor” is the total inflation rate for that period of time subtracted from 1. This just makes it an easier calculation so you can find today’s real value.
So if you made your initial investment 20 years ago, the Inflation Factor would be 0.18.
And if your statement balance is $657,391, multiply the balance by the Inflation Factor you found in the chart:
$657,391 × 0.18 = $118,330
That shows you today’s purchasing power and how much it has eroded due to inflation.
Here’s the equation:
Today’s Balance × Inflation Factor = Today’s Real Value
A shorthand way to write this down is:
TB × IF = TRV
The result will show you how much purchasing power your investment has today.
Here’s a real example:
Say you bought a $5000 I-bond in June 2004.
I-bonds earn interest plus the CPI-U inflation rate, so they are touted as being safe from inflation.
Let’s see if that’s true.
After 10 years your I-bond balance is $7152 (TB = $7152).
Using the table above, the IF for 10 years is 0.40.
So $7152 (TB) × 0.40 (IF) = $2861 (TRV).
Your “$5000 inflation-protected investment” is now valued at $2861.
You lost $2139 over 10 years to real inflation.
By the way, TIPS (Treasury Inflation-Protected Securities) are similar and will suffer the same fate because they both use the understated CPI-U.
By comparison, using the BLS CPI-U IF (0.79), the I-bond would be worth $5650.
You might find it interesting that $650 of the total gain came from interest and $1502 came from the government’s inflation calculation.
We found that number by subtracting the initial investment of $5000 from the TRV using the BLS IF from the chart.
This should be a strong hint that low interest banking investments will only result in a loss, even with the government’s understated inflation numbers.
How to Calculate Gain or Loss of an Investment
To find your gain (or loss) divide the result above by your original investment. Then subtract 1 and multiply by 100 to get a percentage.
A positive number is a gain and a negative number is a loss.
Here’s the equation:
((Today’s Real Value ÷ Original Investment) – 1) × 100% = Gain (Loss)
Or you can write it like this:
((TRV ÷ OI) – 1) × 100% = G
G is positive if you had a gain. G is negative if you had a loss.
Let’s run through an example using the $5000 I-bond above.
We already figured out that TRV = $2861.
And OI = $5000.
So (($2861 ÷ $5000) – 1) × 100% = -42.8%
Pretty easy, huh?
Knowing whether your investments have real gains or losses is critical so you can see how inflation affects your financial future.
Now go ahead and do this for your own investments.
The results will probably surprise you.
To see some real examples of this take a look at “How Inflation Affects Your Investments: Take This 2-Minute Inflation Quiz to Test Your Knowledge.”
You can also learn more about inflation, hyperinflation and deflation in this article.