How fast does an inflation cut the buying power?
Inflation has been occurring for almost 40-year high. Based on the Consumer Price Index, a key inflation metric increased up to 8.3% in April from last year, being the largest jump since 1982 summertime, the United States Department of Labor stated on Wednesday.
It is told that consumers are losing buying power at a quicker-than-usual rate while a slight decrease from the 8.5% rates in March. That occurs due to the prices they pay for all types of goods and services are increasing. They have money yet they buy less.
How does an inflation eat away your savings? The “Rule or 72” solution can help measure its long-term impact.
Rule of 72
Rule of 72 is the rule of thumb generally applied to investment returns. It is a back-of-the-envelope calculation that predicts how many years it will take the investor in making their money doubled at a particular interest rate.
It works like this: Devide 72 by the yearly interest rate to decide the amount of time it will take to double an investment. For example, a mutual fund yielding 2% a year will get doubled in 36 years. One with 6% annual return will do the same in 12 years.
Inflation makes the rule works in reverse: Consumers can predict how fast the higher prices (for energy, food, rent and other household budget items) will share their savings value.
The “Rule of 72” formula applied: April’s inflation rate which is 8.3% shares the consumer’s money value in 9 years roughly. (72 divided by 8.3 equals 8.67).
“The rule works the same whether you’re implying an inflation factor – which is essentially deflating the purchasing power of your money – or whether you’re applying the rule of 72 to growing your money,” said Charlie Fitzgerald III, a certified financial planner and founding member of Moisand Fitzgerald Tamayo in Orlando, Florida.
What To Remember
There are a few cautions to remember, however.
For one, the rule of 72 assumes the inflation rate will keep being higher and constant for a while. It is not clear how long the higher-than-normal inflation will continue. The benchmark interest rate is quickly risen by the Federal Reserve in order to increase the borrowing costs, bring inflation more in check and cool the economy.
Even a healthy economy will experience at least several inflation. The Federal Reserve goals for a long-term rate about 2%. (That inflation rate would share the money value in approximately 36 years, based on the rule of 72).
In addition, the rising costs have no impact on all households similarly. Some families may have their personal inflation rate that is lower or even higher than the national average. Of course, it depends on what they buy.
However, according to the Labor Department, the average worker looked at the hourly pay fall up to 2.6% in April from last year after accounting for inflation.