What is inflation and how do we keep pace with it, or even outpace it?
This short DFA article answers those questions.
Remember when your parents said, “when I was your age, milk cost a ____!” They were probably right! In 1916 a quart of milk cost 9 cents. Now 9 cents would buy you about 7 tablespoons of milk. This is an example of inflation. Inflation erodes our purchasing power; it’s why we typically can buy less of something in the future with the same amount of money we have today. On the bright side, inflation should also increase the size of our paychecks, the value of our home, and the value of our investments.
The money we are saving today to support our future spending is slowly being eaten away by inflation every year. We need cash on hand to live and to have some set aside for emergency purposes, but beyond that we need to protect our money from inflation eating it up. Over time, owning stocks have shown to be a great means towards outpacing inflation (see graphic below), therefore it is imperative we do two things with our retirement accounts:
- Hold very little cash
- Have a diversified lineup of stock holdings
There is no guarantee stocks will keep up with or outpace inflation, but we do know that if inflation exists our money will go down in value – our dollar will still be a dollar, but it will buy less of something in the future – so we put measures in place that might be able to curb the effects of inflation and grow our wealth over time.