If you have been following my recent columns, you know we have been covering the effects that inflation has on your personal financial management. In today’s column, I want to show you the real problem with inflation.
Our entire economic system is taught on a number vs. value basis. We are taught to think in terms of the numbers of dollars we spend, not in terms of the values of what those dollars buy, as if the value of our dollar always stays constant.
If this concept is not clear, let me give you an example. Have you ever taken your house payment, multiplied it by 12 months and then by 30 years and said to yourself, “My gosh, this is times times what I borrowed”? If so, you are guilty of using the number of dollars system in search of value of dollars. In reality, due to inflation your money is shrinking value every year, while your house payment stays constant. So as the value of your dollar goes down, your house payment is actually getting cheaper.
If this number vs. value of the dollar concept is still not clear to you, let me give you another example.
Suppose I handed you a $10,000 gift certificate; think how you would feel. Now, what would happen if we change the date I gave you this gift certificate to the year 2050. How would you feel about receiving this $10,000 then? Obviously, I am not as generous as I was a minute ago, am I?
However, what if the year were changed in this example to the year 1931. My goodness, what could you buy with $10,000 in 1931 (besides a new house and car)?
Can you see what I mean? Money has a direct value that corresponds to the year in which you spend it. Because money has no constant value, many of the financial rules we were taught are no longer valid.
One of the major financial problems for most of us is trying to plan for our financial futures. Additionally, since most of us are still operating on a number of dollars basis, instead of a value of dollars basis, we find out that at retirement we come up substantially short in what we really need.
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In your long-term financial management projections, please do not lock down the value of your money as if it will buy you the same thing in 20 years as it buys today. Thirteen dollar movie tickets would have seemed impossible to someone 48 years ago paying only 50 cents.
In fact, imagine that I could put you into a time machine and send you back to 1969 to find yourself standing in a movie line. How easy would it be for you to have a conversation with yourself and convince yourself that in 48 years you would be paying $13 (26 times) for the same ticket?
Today, you currently have the exact same opportunity, but with 20/20 hindsight. Can you talk to yourself and try to convince yourself that the movie ticket you are paying $13 for today will probably cost you close to $340 in 48 years from now?
You must prepare yourself for the fact that your true future retirement needs 20 to 40 year out will appear just as impossible to be true when you view them today as $13 movie tickets would have seemed to you when looking from a 1969 perspective.
Once you start to unravel the secrets of the science of financial management, you will see that to succeed often means going against the apparent natural flow. But fortunately, some simple changes in philosophy are capable of contributing to massive differences at the end of the game.