Inflation?

Wheaton, IL · Member since 2012 · 55 posts · 2 votes

This is such a basic question, but I don't quite understand the basics of it.

If my income increases by 3.5% per year (that's my current raise per year per our contract) and inflation has been between 3-5% per year, how can my standard of living ever legitimately increase?

Obviously some people increase their standard of living as their career advances. I observe people who have gotten 3% raises throughout their life and they live better at age 50 than they did at age 30. There's the argument that they've paid off debt. Even with that being the case, if inflation is indeed 3-5% per year an electric bill in 2013 that is $100 will be close to $200 by 2030. So even while paying off debt, other expenses are increasing. How does anyone improve their SOL?

When I say SOL I am referring to more disposable income and less debt-income ratio, etc.

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J ScottPro Member

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Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes

13y

If your income only increases at the rate of inflation, your standard of living *won't* increase...that's why you're going to want your income to increase faster than inflation... :-)

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Matt Y.
Homeowner · Lodi, CA · Member since 2013 · 19 posts · 1 vote
13y
See now I think that's a great question although some might not, despite it being in the starting out section. Yeah I see what you mean, which is why I won't retire with a full time job if I can help it--I'll retire with a boatload of properties and someone managing them for me.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
13y
If your income only increases at the rate of inflation, your standard of living *won't* increase...that's why you're going to want your income to increase faster than inflation... :-)
Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
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Richard Vang
Real Estate Investor · Carmichael, CA · Member since 2013 · 111 posts · 16 votes
13y
With inflation kicking in, it's definitely very hard to keep up SOL. So, normally, the advice is, at young age, start saving early. Use the saving to invest to generate passive income. You will get your income that even out by inflation. But, if your investment is decent, you will still get roughly 8%-10% from your investment. Start saving and invest as early as possible. This is because of the "compounding" effect. You will be doing better as your investment snowballing for you. Let the money work for you.
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Stuart DuBrier
Falls Church, VA · Member since 2013 · 4 posts · 1 vote
13y
Great question! Although I would agree that a person who is in their 50's today lives a better SOL than they did in their 30's, I would suggest that increase is a result of the higher standard of living in the country as a whole and not their relative SOL compared to their peers at the same income level. Median income for the last 20 years has been flat when adjusted for inflation (http://en.wikipedia.org/wiki/File:US_real_median_household_income_1967_-_2011.PNG).

At 3.5%, you're your purchasing power would have increased about 11% over the last decade since inflation over that period has only been 2.43%. I read an article yesterday (http://www.economist.com/blogs/freeexchange/2013/09/generations?fsrc=scn/tw/te/bl/meaningofinflation) that suggests inflation rates should remain low based on demographics. I've also heard arguments that inflation will be kept (artificially) low through monetary policy so the service on our national debt remains manageable.

So how does anyone improve their SOL? My solution is to create more value for more people than you currently do. If your salary increase is limited to 3.5% a year, create value somewhere else (i.e., real estate). As a member of the military, my raises are typically tied to the Employer Cost Index, which should be about 1.8% next year. With such a low raise, I'll be buying some multifamily properties in the next 6-10 months to increase my SOL.
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Scott W.
Real Estate Investor · chicago, IL · Member since 2012 · 1k+ posts · 231 votes
13y
Albert Einstein called the magic of compounding interest his greatest mathematical discovery ever.

If you begin to save for retirement in a 401k or Roth IRA at an early age, you will be fine.

I started when I was 22, straight out of college. I have always been in 100% stocks/equities. When things started plummeting I did my best to buy more. 21 years later, I am getting there.
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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y
You've grasped an important concept. Cost of living increases just keep you level. Inflation is hard to predict, too. Its been low in recent years, even the last couple of decades. Back in the early 80's it was over 10%.

You need to do several things:

1) Save, save, save. No matter how little you make, save 10%. Get a "baby emergency fund" as Dave Ramsey calls it, then a real emergency fund (six months expenses), then build your nest egg.

2) Live below your means. This goes with the saving bit. If you spend more than you make, you're doomed. Somehow, you have to adjust your life to spend less. This is hard when you're not making much. It can be even harder if you make a lot.

3) Avoid debt. Ramsey says avoid debt period. Many here, me included, think debt is OK if its its earning you money. Like leveraged rentals. Even then its a two edged sword. Debt for expensive doodads like houses you live in, cars, boats, furniture, vacations, dining out, etc., etc., etc. is nothing but bad.
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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
There has to be something to be said for decreasing expenses though too, right? My primary housing expense (principal and mortgage) is 26% of my total income. If you add 10% inflation it brings housing (P and M) expense to 22.5%. That's a few hundred dollars a month right there.

Housing is probably the only expense that works like that, but still.

Also-I would like to think I'll be better off in 10 years than I am now because I'm spending alot of money on a new furnace, cutting down trees close to my house that are dangerous, rewiring areas of my house that were previously dangerously wired. Maybe I'm living in rainbow land but maybe in 10 years I won't be spending money on that kind of stuff?

I have to make myself feel better here. I feel like I'm never going to get ahead on my teachers salary. That makes me a little saddened...
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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
Now that I'm thinking about this, I still don't get it. I understand the concept that if your income increase per year does not exceed inflation per year then your SOL will not increase. I get that.

However, for example, here's my situation. I currently make 42K myself (I live in a depressed rural area). I have 7 years in the school system. In another 10 years I will have 17 years in the system and I"ll be making the equivalent of 55K (whatever that looks like in inflated dollars) So in 10 years I will be making more money at 17 years experience than somebody with 7 years experience. Doesn't that, by default, give me a higher standard of living (assuming I'm not increasing my expenses willingly)? If the answer is no, then by default, the person with 7 years experience would lose SOL in comparison to my 7 years in the year 2013. If that's the case, in 50 years all entry level jobs would make no money, at all. I don't understand this...
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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y
If you actually get a 3% raise per year for the next 10 years your gross income will be $56,444. Economists refer to those dollar as "nominal dollars". That is, that's what will show up on your paycheck and you'll spend at the grocery store. That's a 34% increase, which is 3% compounded annually for 10 years.

Economists also use the term "real" dollars. If inflation is actually 3% per year for the next 10 years, then you will be making exactly $42K in "real" dollars vs. right now. That is, prices for bread, furniture, gas, cars, rent and everything will have also risen by the same 34% over those 10 years. So, your standard of living will be exactly the same as now. That is, your $56K paycheck will go exactly as far 10 years from now as your $42K paycheck does now.

If, 10 years from now, a teacher who's been working in your district is only making $42K, then their standard of living will be lower than your's. They will be living on a paycheck that's equivalent to $31,251 today. So, yes, you will have a higher standard of living than that less experienced teacher.

More strictly, you'll be getting paid more than that less experienced teacher. As @Stuart DuBrier says, our standard of living are vastly improved over our ancestors. If you compare your life to that of Andrew Carnegie or John Rockefeller you will find that your standard of living is, in many, many ways, much higher. If you compare it to King Henry VIII or Genghis Kahn its truly, amazingly better. You no doubt have amenities in your life that you consider totally routine. Like running water and a warm bed. The ability to drink water without risking your life. The knowledge that a minor cut or diarrhea is not life threatening. Enough food to fill your belly every day. Those were luxuries even emperors once didn't have. If you don't believe me, read the book "Abundance". The author provide many detailed examples, backed by research. And also explains why your brain is programmed to convince you otherwise (its so you can avoid being eaten by a tiger. Another risk that just isn't a problem for most of us.)

Yes, you're living in rainbow land. That furnace may last more than 10 years, but it won't last 20. Neither will your roof, fridge, and a lot of other stuff. These are the ongoing and continuous expenses that come with owning a house. These expenses will never end. Prepare for them and expect them. Or rent and let your landlord deal with them. Renting is not necessarily a bad thing.

You could have an event like me. Eight days ago I had four feet of water in my basement. Seven days ago I had a $350 30 yard roll off in the driveway. Filled with thousands and thousands of dollars of possessions. Fridge, freezer, all the food that was in those, washer, dryer, clothing, desks, beds, drywall, laminate flooring and stuff I can't even list. All the art materials and tools my wife had accumulated over the last 30 years. Today alone I spent $300 on rental dehumidifiers and $3000 (more actually for permits and code upgrades) on new furnaces. There are many folks around here hit much, much worse than me.

You're making an assumption that the less experienced teacher is actually making less than you. That may or may not be true. I'm not a manager in my day job, so have no visibility to actual pay scales. But I have a pretty good idea that new hires are making MUCH more than I was paid when I graduated with a BS in 1981. Even back then software engineers were in high demand and we were given fairly large raises (like 5%) at frequent intervals (like six months) in order to stay ahead of new hires.

The real key if you want to improve your standard of living is to increase your income at a rate greater than inflation. Real estate gurus would have you believe that's just a matter of buying their course. That could be the right path for you. But it could be something as simple as moving out of your "depressed rural area". It might be getting a masters or PhD. Or moving up to teaching at the university level. Or doing something completely different. But if your choice is to do exactly the same thing for the next 10 years, then don't be surprised if the future isn't much different than the present.

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Stephanie Dupuis
Residential Real Estate Broker · Bremerton, WA · Member since 2013 · 494 posts · 142 votes
13y
Hi John -

Great topic.

I was a teacher and had these same thoughts about 5-6 years ago. I started a business (a fishing tackle company) and left teaching. I also started tutoring and still tutor (I teach music lessons). I make 19% more money in private teaching ( and I work 25-30 hrs/week vs. the 60-80+ hrs. I was working as a teacher) than I ever did teaching in the schools. I'm S corped now. So in addition to earning more annual income, I pay less taxes and keep more of my income. I pay my own insurance which ended up being a better deal than the school district, and I'm not paying $86/mo in union dues. The insurance deductions, union dues, mandatory pention withdrawal, etc. all added up and I was taking home very little at the end of the month. I had little control over my money. This was eye-opening to me and only my first step out.

In the next few months, I will be transitioning careers again. Making more money is important to me. I want money to invest. I still maintain low living expenses - I still live on my first year teacher salary in my mind and I invest the rest. But, purchasing one rental a year is too slow. My goal is four rentals per year.
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Ryan R.
Real Estate Investor · Central, TX · Member since 2012 · 479 posts · 165 votes
13y
Originally posted by Jon Holdman:

Yes, you're living in rainbow land.

This is great Jon!

Also, an interesting article about household income comparison in real dollars.

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/17/the-typical-american-family-makes-less-than-it-did-in-1989/
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Xing Zhu
Durham, NC · Member since 2012 · 498 posts · 48 votes
13y
The inflation in the past 30 years has been relatively mild due to the massive import.

Certain sectors such as high education have higher than average increases of costs because such services cannot be imported. Otherwise the most observable inflation in the recent years are energy related.

Another factor contributing to higher living standard is that the borrowing cost is much lower now than before. As a result, people now live in much bigger houses than 30 years ago. Do you believe that most houses over 10,000 sq ft in the US were built in the last 15 years?
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Harry M.
Real Estate Investor · Dallas, TX · Member since 2010 · 449 posts · 173 votes
13y
@John Jabson

You pretty much nailed it. If you own your house and have a mortgage, you get some relief due to the P&I portion of your payment devaluing over time, but for the most part you will see no real increase in your spending power if your raises are about the same as inflation.

A lot of people in a day job hit this point eventually. At first you get raises fairly easily as you gain experience and get better at your job. Then later through promotions, adding extra education, or jumping employers. But eventually you get maxed out within a certain field without making radical changes which may or may not be worth it for your overall happiness.

That was pretty much the situation I found myself in. I still really enjoy my day job, but the last raise I got that was substantially over 2% was in 2008 (I was 16 years into my career at that point). I responded by deciding that I was responsible for giving myself my own raises. We optimized our living expenses (no ramen noodles, just finding smarter ways to do things and cutting out useless crap), paid off our mortgage, and started working on accumulating rental properties. It's a slow process, especially at first, but ultimately the day job will only take you so far - the rest is down to putting the money you are able to save to work.
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Xing Zhu
Durham, NC · Member since 2012 · 498 posts · 48 votes
13y
For an active investor, inflation often provides a great opportunity for building up his wealth.

The key is to understand the extreme nonuniform nature of the inflation. For example, in the last ten years or so, a main driver of the inflation has been the rising of oil prices ($147 a barrel on July 11, 2008) together with other natural resources. Good active investors have made huge profit by trading on oil and natural resources. This type of profit making rate is by far higher than the inflation rate. In 2008, average investors probably lost money. Good active investors made money in that year on both long and short sides. Remember the oil price was up all the way to the middle of that year. In the second half of that year all asset classes declined together. According to Futures Magazine , many managers made more money in 2008 than any of the previous years.
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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
In my case, my raises are about 3% per year but our salary structure changes every few years. For example, when I came out of college in 2004, our district paid 28-30K for starting. Now we pay about 34K for starting. That's clear that the salaries are going up in addition to the 3% raises per year. That, itself, is why my coworker, who has 20 years experience, makes 60K while I make 42K and thus has a higher wage and spending power than I do.
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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
With that being the case, my SOL should increase?
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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y
That colleague making $60K with 20 years experience has been on the job 13 years more than you. If, 13 years from now, you're making $60K, no your standard of living will not change. By that I mean the purchasing power of $60K 13 years in the future will probably be about the same as $42K right now. Your colleague that's making $60K right now has more purchasing power than you.

I'll repeat this: If you just continue to do the same job in the same place you are right now you should not expect your standard of living to change very much. Ever.
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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
You're missing what I'm saying here...in 13 years I'll be making the equivalent of today's 60K. It might be 75 or 78, whatever it equals out to be. Therefore my standard of living will increase slightly, I think...
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Matt Devincenzo
Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
13y
@John Jabson so based on your last post what you are saying is that you have two methods of your salary increasing:

1) When the pay scales are updated periodically to adjust for inflation your pay will adjust as well. (assumed 3.5% for simplicity here)

2) You maintain your 3.5% increase/year for the number of years in that position.

So if today your position base salary is 34K, you earn 42K based upon having 7 years experience entitling you to a 24% "premium".

By the same logic if 13 years from now (20 years total service) the position pays 50K, you would be entitled to 84K based on your 20 year "premium" of 70%. Which means that you would be earning the equivalent of 58K today.

If that is the case then yes your SOL will be able to increase because your pay will reflect both an inflation adjustment built into the pay scale increase, as well as an actual raise increase based on your years of service.
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Rich Weese
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
13y
I love inflation. In order to feel that way, I must own real estate-otherwise I'm screwed. As long as there are only 24 hours in a day, I don't feel salary increases are going to mean much. Until you can clone yourself, you have to progress with investments, imo. Lots of good advice in this thread but I still believe only a couple ways to get ahead:

1. Real estate ownership

2. Reduction in taxes by converting current personal expenses into actual tax deductions.

I've been around long enough to see the benefits/destruction of inflation. You can choose which. Rich
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Linda L.
Monterey Park, CA · Member since 2012 · 56 posts · 3 votes
13y

3% inflation is more of official number.

So your employer can justify why the basic merit increase is 3% only.

Assume inflation is only 3% for 15 years, It’s 55% increase of your price. Meaning even though 15 years later, the price increase to 55%, you are supposed to get the same quantity for what you paid for.

In 1998, I remembered that one gallon gas cost $0 .99-1.2

15 years later, it cost $ 3.8-4.2. That’s 400% increase. That equals 9.7% yearly inflation.

Using the same car, the same gallon gas still only get you the same mileage as 15 years ago, maybe even less with the car aged 15…..:)

So to keep your basic standard of living, you need to do better than 3%, whether it’s from job promotion, savings or investments.

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John Jabson
OP
Wheaton, IL · Member since 2012 · 55 posts · 2 votes
13y
If our wages remain stagnant like they have in the last 30 years, we're not going to have a middle class in another few decades.
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Mike McDermott
Real Estate Investor · Sun Prairie, WI · Member since 2014 · 68 posts · 100 votes
12y
Whew! Another Chew Subject.

If your income by 3.5% and inflation increases by 3.5%, you're even, right?

I'll go through an example, and you decide.

I'm going to use 4% since the math is easier. Let's say you have $100,000 in the bank earning 4% with inflation being 4%. Even-Steven, right? Well at the end of the year your principle, the $100,000, is worth 4% less than it was at the start of the year. So in real dollars, your $100,000 only worth $96,000 in spending power.

Hey but you earned $4,000 right? Yes, your account says you've got $4,000 more in slips of green paper, but each one of those dollars has fallen to 96 cents.

4,000 x .96 = $3,840. So the interest you've earned has only $3,840 in spending power as compared to the start of the year.

$96,000 + $3,840 = $99,840!

To break even with inflation at 4%, you actually need to earn 4.17% And that's just to break even! To make a true return, you must make more than that.

But there's another factor: TAXES!

Unless you know something I don't, there's no deduction for inflation on the 1040. If you're not earning in a tax free environment, the double whammy of taxes and inflation will eat your gains alive. Consider this.

You earn 4% in a bank (I know, not possible these days). You're in a 25% federal income tax bracket. So you have to pay 1/4 of your earnings in taxes. So of the 4,000 slips of green paper you've earned, you have to pay 1,000 of them. You get to keep 3,000 dollars. But your spending power of those 3,000 have shrunk.

3,000 x .96 = 2880 consequently $96,000 + $2,880 = $98,880.

So you need to earn 5.556% just to break even with inflation and taxes. Follow me on this.

$100,000 x 5.556% = $5,556.00 (Cash earned on savings or investment.)

$5,556 x .75 = $4,166.67 (Federal Marginal Tax Bracket of 25%.)

$100,000 + $4,166.67 = $104,166.67 (Nominal Account Balance)

$104,166.67 x .96 = $100,000 ("True" Value of money after inflation of 4%)

My apologies to the math impaired. I tried to make this as simple as possible.

My point is that you're never just dealing with inflation. Inflation and taxes are the two sneak-thieves that rob you blind. So if you don't know what you're battling, you won't be able to make a plan to win. This is why we can say "THE MORE YOU SAVE, THE POORER YOU GET!" If your savings don't account for the one-two punch of inflation and taxes, your going to fall behind every year.

I'm not going to walk through the math on this one, but if you want a TRUE return of 4%, with inflation of 4% in a 25% tax bracket (yes, I haven't even taken into account state income taxes), you'll need an 11.11% return.

11.11%!

That will give you a 4% real return.

If you were to lend money out of your Roth 401K (no taxes on your money ever again) you would only need an 8.33% return to garner a 4% real return after inflation.

Can you see why Americans are earning more and more each year, but real income has shrunk? Can you see why saving in a bank is useless and investing in mutual funds is almost as bad? Can you see why investing in real estate where you can control your costs as well as your expected returns is one of the few asset classes that give you the freedom and control you need to insure your financial future?

How simple is this? You're looking at a possible real estate deal. You're in a 25% Federal Income Tax Bracket. You believe that inflation is 4%. You want to make at least a 4% true return. You think to yourself:

"Hmmmm..... I buy the property for this much; it costs me this much to fix it; comps in this area are X, so if I sell it at a discount from comps I'll still make

11.11%!

Great! I'll do it!"

And if it doesn't make 11.11% you don't do it. Easy.

Good luck, and keep investing in real estate.
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Xing Zhu
Durham, NC · Member since 2012 · 498 posts · 48 votes
12y
Another reason for some people, without raises beyond inflation, to feel that they live better than before is the fact that MONEY itself has been "deflating." This may sound peculiar . What I meant here is that the borrowing cost of money is lower and lower and as a consequence, e.g., many are living in bigger homes. Is it true that in the US, over 90% of houses over 10,000 sq feet were built in the last decade?
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Marcus Johnson
Investor · Apple Valley, MN · Member since 2013 · 281 posts · 94 votes
12y
This is why my wife and I invest aggressively in Vanguard Index funds which follow the S&P 500 and have averaged around 11% before inflation and are just starting to put our money to work in buying real estate investments which will beat inflation hands down. So if you plan to stay at a career that goes with inflation you'll need to invest and take some risks.
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