Saturday, October 2, 2010

The Invisible Tax


This article is about that unseen tax that on average steals 2-3% of our money’s spending power each year. This tax is known as inflation. On average our money loses 2 to 3% of it’s value each year, this is mainly due to the increase in the amount of money circulating in the country. There are many other complex factors involved that influence inflation rates, but the important thing to note is that on average our money loses value. This means that in about 30 years what would have cost us a $1 (say a can of pop) will cost $10, a whopping 10 fold increase (that better be the best damned tasting pop ever!).

Inflation is also known as “The Widow’s Worse Enemy” (sorry for the sexist remark). It was given this name during World War I. During this period most men went off to fight and when they did not return their wives would be left a lump sum settlement from the government. Being that men were the main bread winners (earners) during that time the widows would have to invest their money to live off the interest. Most widows would invest in a fixed income investment (i.e. bonds) that would pay a constant interest rate each month. Widows who depended on their investments to survive saw the cost of living persistently and gradually increase each year due to inflation, while their investment income remained the same. Most widows in this situation were forced to work in old age or suffered alone in poverty.

Before we can even worry about inflation it is critical to pay off all your bad debt (Check out: Know your Debt & pay-off-debt-or-invest.html). After your debts are settled you can begin to invest (Check out: top-4-forms-of-passive-income.html). When looking for an investment you have to beat the average inflation rate. Otherwise you’re not producing any extra value with your investment. Most “high-interest” savings account offer an interest rate that is a complete joke. I believe most banks are offering something like 1%. That means that your money is losing value at 2% a year instead of 3%. Leaving your money in one of these accounts would be a bad idea. Your money has to be in some kind of investment vehicle that at the very least is beating the average inflation rate.

There will be many questions to ask yourself when examining investment options. One of the first questions you should always ask yourself is: “will my return on investment keep pace with the average inflation rate (2-3%).” Having your money in the bank is not a terrible idea. It’s a safe place to accumulate your savings, until you have a sizable sum it's difficult to make a serious investment. When your savings do grow to a large enough sum (say more than $1000 or so), then it’s time to start thinking of ways you can make that money work for you. Don’t let the invisible tax erode your spending power. Become a wise investor and kick inflation’s ass!


Check out this Rich Dad video on inflation:

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