The Stealth Tax – Inflation

The one tax you don’t report on your tax return

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

John Maynard Keynes

Inflation is one of those wealth eroding factors which can have a serious impact to your wealth over time.  Take a look at the below image to see how it has impacted purchasing power throughout the years.

Whether we’re rich or poor, thrifty or overextended, inflation is as inevitable as death or taxes. But how high IS inflation? Is the Consumer Price Index a reliable guide? And what is the impact of underestimating inflation?

In an effort to gauge how much you need to save and how far your money will go in the future, most financial planners will run projections based on 3%.  With the recent US Bureau of Labor Statistics reporting an annualized 2.8% jump in the CPI index over the last 12 months, 3% seems reasonable.

The dirty secret behind inflation is that it is a lot steeper than we are led to believe.  There is a good reason why those 2 or 3% cost of living raises don’t seem to keep pace with the economy… they’re not.

The problem with the pricing methodology is that it paints an inaccurate portrait of inflation. The CPI measures inflation by how much the price of a “basket of goods and services” used by consumers changes over time. But the basket itself actually changes.

Not only that, but some important expenditures are left out. For instance, the actual price of purchasing a house is not factored in, only an estimate of what it might cost to rent that house. Since house prices rise in value faster that the CPI rates, the CPI can’t accurately reflect a true cost of living increase.

Learn more by reading The Truth about Inflation.

So, How Can Investors Deal with Inflation?

There is no magic bullet, but here are a few things that can help:

  1. Estimate on the high side rather than the low side for inflation. We recommend using 4% at minimum, even though it may be discouraging to see how your dollars shrink
  2. Work longer and save more. As Kim Butler argues in Busting the Retirement Lies, the model of working until 65 and hoping you’ve saved enough to live on for another 25, 30, or more years is a simply a broken model that does not work for most Americans.
  3. Make inflation work for you by owning assets, not just dollars. Use or leverage against the dollars you have saved to purchase income-producing assets such as rental properties or a cash-flowing business. This way, you’ll at least be on the right side of the buyer-seller equation where inflation is concerned.
  1. Store your safe money in more efficient vehicles that can outpace inflation. Bank rates are far below the true cost of inflation. There are other options outside of the typical banking environment that can keep pace with inflation while still allowing easy access to your funds.