Monday, October 31, 2011

Inflation influence

Inflation. There is so many articles written about inflation, explaining benefits and downsides of it. 

What does it mean for an investor?  Part of the budgeting is  not only see how are you doing now and where the money goes to, but to have vision how to get from A to B.
Using my portfolio I will demonstrate clearly how does it mean an additional 10 (ten) years of work. The prospects and planning without taking inflation into account are rosy and glamour:

This means, that should I keep my contributions at $40 K a year, I will reach my target of financial Independence ($60 K a year from my investments at 3% interest) between 2033 and 2042, depending on the stock market performance.
My emergency fund and precious metals are not contributing towards growth - I use interest rate for the savings account at the inflation rate. It does not exactly right, but it simplifies.
This is a bit disappointing but let's have a look at the inflation adjusted scenario:

 I assumed inflation at very moderated level at 2%.
At the expected stock market growth at 3% and annual contribution of $40 K I will never be able to reach my target in life time, the similar for 4% & 5% - just normal working life till you are in high 60-ies.

Two arguments I would like to address now:
- Should I risk it and invest my emergency fund and precious metals in the stock market it will only buy me two to three years.  In comparison with the project timeline and investment it is too risky.
Risk is likelihood multiplied by potential consequences. In this case be temporary out work and not be able to provide for the family vs. 2 years on 30 years scale.  Another contributing factor - is very bad stock market performance in recent years.
- My salary will grow and /or match inflation .  There is no supporting evidence of that, that is why gap between the rich and the poor is growing.
This is just simple facts.  Should I drop some of my needs or wait till 2047or what else could I do?

The next question, if the stock markets continues to perform badly - it is too risky to invest in it for 1-2% growth a year.

1 comment:

  1. Great idea, listing different scenarios in a table like that. I think inflation in the future years will likely be around 3%. I don't have a lot of precious metals in my portfolio because I don't really like them. But to fight inflation and market volatility I'm actually thinking about increasing my gold exposure. Do what you think is best for your family.