If you’ve caught much news lately, you’ve probably heard the word inflation being thrown around. Inflation is when money loses its buying power. When your money loses its buying power, you have to use more dollars to purchase the same goods and services. For example, if inflation is at 10 percent, that means that goods that used to cost $100 would cost $110. This can wreak havoc on people’s finances, particularly if you are low income. What causes this phenomenon? Here are couple of major causes.
Easy Access to Debt
Being able to easily access debt lowers the value of money. If interest rates are kept really low or loan standards enable people to easily qualify for a loan, people are more likely to borrow more money to purchase goods and services. You can see this impact in houses and cars. If people can borrow money at a low interest rate, they are often willing to pay more for a house since the monthly payment is more likely to be an amount they are comfortable with paying. Back in 2008, borrowing standards were so low that people with no income were able to get houses in some instances. This easy access to debt kept home values climbing until the whole system crashed under the weight of these high-risk lending practices.
Also note how common it is these days how many everyday people are driving cars that cost 40 or 50 thousand dollars. This all boils down to the fact that access to debt is so easy that people can borrow to pay for more expensive cars. When money is relatively easy to get your hands on, this creates the effect of lowering the dollar's value because accessing money is much less painless.
Government Spending
Typically, your government spends money that it does not have. They often accomplish this by using the Federal Reserve to get the funding they need. The Federal Reserve basically acts as the United States Bank. Their name is deceiving because they are not a branch of the federal government but they do serve a purpose-monitoring the money supply. They also lend money to banks who then loan the money out to regular people or businesses.
The government generally spends more money than it takes in from tax revenue. They could simply tax people in an attempt to get the money, but that tends to make winning elections more difficult. It is much easier for them to go to the Federal reserve and have them inject the additional money they need into the economy.
The more dollars there are in the system, the less each of them is worth. Look at it this way. If everyone had a million dollars, would a million dollars be considered a lot of money? No. The reason it is considered a lot of money is because so few people have it. When the Federal reserve adds money to the system to compensate for government overspending, it makes the value of the dollars you have go down. You still pay for the government spending, however, you pay for it through inflation, instead of being taxed directly. On average, money loses about 2% of its value every year but in recent times it has been 7%. If you had $1,000 in the bank account last year, it has the buying power of $930 today. During the coronavirus era, the government injected large sums of money into the economy to compensate people while they were not working. In addition to this you still had your regular government spending going on which was already above what the government takes in through taxes. This made inflation even worse.
No matter where you are on the political spectrum-liberal, conservative, or somewhere in between, the fact is that much of your money’s lost value comes from government spending policy.
Why is This important?
It is important to be aware of what inflation is and its negative impact on your finances. Generally, people are only taught to work, pay bills, and then save a little money if you have any left over. However, money that is saved is losing value through inflation.
In order to come out ahead, you have to do more than just put your money in the bank. You have to put your money in seeds that will give you a return that beats inflation and builds enough money where your average returns provide for you into old age. Some examples are mutual funds or exchange traded funds. A fund that tracks the performance of the top 500 companies in America(The S&P 500) averages a 30 year return of 12 percent. Investing one hundred a month invested in a fund that tracks the S&P 500 from age 25 to 65 would be over 1 million dollars. at that rate. This is why investing is so important!
Few jobs pay enough money for you to save your way to financial security. Investing is key to achieving financial peace. If you need guidance with building an investment plan, reach out to us today. The sooner you can get started, the more prosperous you can be.