…Inflation and Rule of 70…
With inflation raising its ugly head, it’s helpful to use the rule of 70 to estimate the effect of inflation on our lives.
Many people are aware of the rule of 70, but some are not.
This will remind people about the rule, and, perhaps, make others aware of it.
Here are quick introductory examples:
- An inflation rate of 10% will result in food prices doubling in 7 years.
- An inflation rate of 2% will result in food prices doubling in 35 years.
The rule of 70 can be expressed as a formula:
To determine the number of years for doubling to occur,
divide 70 by the rate of inflation
The rule can also be used to determine how quickly an investment will double by dividing 70 by the rate of return.
The rule allows everyone to see how the rate of inflation will affect their lives.
Here are some examples.
A person who is about to retire on a fixed income can determine how inflation will affect the purchasing power of his/her fixed income.
- With an inflation rate of 7%, a person who is 65 years old, retiring with an income of $50,000 per year, will have the purchasing power of their retirement income cut in half in 10 years, or when they are 75 years old.
To put this in perspective: Could this person live today on an income of $25,000?
- If the rate of inflation is only 2%, it will take 35 years before the purchasing power of the retirement income is cut in half.
Buying a home
A young couple is trying to save to buy their first home which currently costs $200,000.
They calculate it will take 4 years before they will have enough money to make the purchase.
With inflation of 10% the house will cost $400,00 in 7 years. (In 4 years it will cost $293,000.)
With an inflation rate of 2% the house will only cost $212,000 in four years.
When the rate of inflation is high, the couple is motivated to borrow money and buy now to take advantage of the inflation induced increase in valuation they will experience by owning the appreciating asset.
This is true for every purchase: The motivation is to buy now, before prices increase.
Wages and prices
During periods of high inflation, workers will demand higher wage increases, which leads to labor unrest and strikes.
Higher wages will then feed inflation as businesses, up and down the supply chain, try to recover the higher wages paid to employees by increasing prices.
The rule of 70 can be used for comparing outcomes with differing growth rates. For example, population growth can be estimated using the rule of 70. A growth rate of 0.7% doubles in 100 years.
Recent inflation data
As reported by Value Line Research:
“Recent data did not alleviate inflation concerns. The Labor Department reports showed that both consumer and producer prices jumped markedly in February, with respective 12-month increases of 7.9% and 10.0%.”
Inflation, once started, perpetuates itself.
The rule of 70 allows everyone to quickly calculate how various rates of inflation will affect their lives. It also allows them to see how their investments will perform.
People on a fixed income, such as retirees, are hurt the most when the rate of inflation is high.
But everyone is hurt as prices rise ahead of growth in income.
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