1973 vs. 2013

Written on October 7th, 2013 by James

A recent Powershares Investment Workshop got me thinking about inflation.  Often times we hear about the massive increase in prices of items and on the surface it sounds like a huge return, until we factor in that most other items have risen at the same rate or more.  Case in point is when you hear that your grandparents purchased a home in the 40′s or 50′s for what seems like a modest  amount of money (for a home) and then sold it for $300k.  So let’s do the math:  $40,000 home in 1950 sold for $300,000 in 2013.  That seems like a huge return on the surface, but over a 63 year time period the increase is simply keeping up with inflation, a return of 3.25% annually!  But more than the return is the concept that everything increases with inflation: the cost of food, a postage stamp, a can of soda and your income!  If your salary is keeping up with inflation then your percentage of income to buy that $40k home back in 1950 is equivalent to your percentage of income to buy the more expensive ($300k) home in 2013.  Make sense?

To grasp this let’s take a look at two graphics from the American Enterprise Institute that detail the amount earned by a college student over his/her summer break and what they spend that money on.  One is from 1973 and the other is 2013:

 

 

What you notice is that while things get more expensive, in a perfect world your income would rise to compensate for it.  Inflation is another way of saying the purchasing power of the dollar diminishes over time, so to keep the same lifestyle (as things get more expensive) then your income must rise as well.  It’s when those “things” continue to get more expensive and your income stays stagnant that we encounter purchasing power erosion and really feel the effect of inflation, but that is for another blog.

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