To give you a basic understanding of inflation, just think about how the price of something has gone up over time: for me, I always think back to "$2.50 Tuesdays" at the movies. I have to imagine this was between 15-20 years ago now (I never thought I’d be able to say that about anything – guess I’m getting old…), but these days, I think it’s closer to $10-$13 on the "cheap" days depending on which theatre chain you frequent. (And if that wasn’t enough, they’ve started playing commercials in addition to the new movie trailers – so without the commercials, it would be even higher!!).
Anyways, consider inflation to be the general increase in prices over time. There are many examples and types of inflation (demand-pull inflation and cost-push inflation, e.g.) but I won’t go into that in this post. But what I will go into are some analogies that helped me understand inflation.
I’ve often heard that "your parents paid more for their last car then they did for their first house." I know in this case this is true: my dad’s last car was $60,000 and his first house was $26,000. Ask your parents what they paid for their first house – they always seem to chuckle when they mention it… :)
But that doesn’t mean that people are necessarily having to work harder and longer to be able to afford the same things over time. I remember being told that in the decade of the 1900’s, the average MONTHLY salary in Canada was $3. By 1930, the average monthly salary was $30. 1960 = $300/month. And if you told someone in 1960 that they would be making 10 times that amount by 1990, they would laugh you out of the room. Well in 1990 the average monthly salary in Canada was around $3,000 after all (for a total annual income of $36,000). Not so crazy it seems. So by that logic, people should be earning $30,000/month on average in 2020…
…hey, we laughed at a comment like that in 1960! :)
Incidentally, if you wanted a million dollars worth of TODAY’S purchasing power 30 years from now, what do you need to have saved up? Well, instead of aiming for $1 million dollars like everyone does, once you factor in inflation (let’s use 3%) you need to plan for $2,493,722!
So: moral of the story? Factor in inflation in all your calculations! How much you need to save, how much you earn, etc. I always use 3% as a base and then adjust accordingly – i.e. for salaries, I might peg it at inflation + 2% to show that people actually get paid more for what they do over time to compensate for their increased experience, efficiency etc. If you only get a raise based on the CPI increase (rate of inflation) you aren’t actually getting a raise!!! Your purchasing power will remain the same as the prior year… :(