Why Purchasing Power is More Important than Investment Profits
Growing your money is not the most important element of wealth. In fact, growth should come secondary to the preservation of wealth and purchasing power. Too often do investors get distracted with nominal changes in their personal wealth only to find that the thousands of dollars they have collected is worth considerably less than it was when the initial investment was made.
Purchasing Power 101
Purchasing power is a calculation of how much you could buy with X amount of money. Although prices seem stagnant in the short term, and are even
depreciating for some products, general increases in consumer prices are only a natural response to inflation.
Purchasing power should be at the forefront of a proper investment plan. Does it really matter if your investments are on track to be worth $1 million in 20 years if a loaf of bread will cost $20 and a gallon of milk $50?
The Failures of Cash Investments
Many people falsely believe that by storing cash in an interest bearing savings account or certificate of deposit, they are hedging themselves against inflation. However, this is rarely the case. Because bid interest rates (those you receive for lending, or depositing, in a bank) often lag true inflation, the damage to purchasing power is done long before true inflation in prices arrives.
CPI is Not an Inflation Measurement
Many banks and institutions sell “inflation-protected” debt instruments that are tied to the inflation rate. Usually, these investments pay a certain percentage per year with a bonus added to rival the inflation rate, thus guaranteeing that investors always earn more than the rate of inflation.
This couldn’t be more intellectually dishonest, as the Consumer Price Index fails to take into consideration the change of the money supply, but rather the change of prices of consumer goods. The CPI is calculated by finding the prices for a “basket” of consumer goods and charting the average change in price over a period of time. Much of the “basket” is centered on consumer staples like groceries, gasoline, etc., as they make up the most basic elements of modern life.
Where the CPI Fails
One of the failures of the CPI index is that it only reflects the changes in the sticker price – and not the changes in the amount of the consumer goods. If you visited a grocery store in the past ten years, you have likely noticed that the sticker price of many goods has not changed, but the weight of the product has. For example, bags of sugar (one part of the CPI) were almost universally sold at $1 per 5 lb bag until five years ago. Today, you’d be hard-pressed to find a single 5-lb bag of sugar, as most companies have begun to sell 4 lb bags, but at the same price of $1 per bag.
Although the price did not change, the quantity did by 20%. However, this change went unnoticed by the CPI calculation.
How to Track True Inflation
The only way to track the true inflation rate, and thus protect your spending power, is to invest in hard assets (commodities, physical metals, etc.) that rise in value as the value of the dollar drops.
Gold and silver especially track the change in the money supply with accuracy, as the amount of gold and silver at the surface of the earth proportional to the number of people remains consistent. In contrast, inflation increases the amount of dollars in circulation. When you have more paper money while the supply of precious metals stays consistent, this only leads to an increase in the value of the precious metals themselves.
The only way to preserve your spending power and your wealth is to meet or exceed the true rate of inflation, not the rate of inflation as calculated by complicated (and often corrupted) economic models.
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