The Inflation Rate that Many Never Factor

Amar Pandit , CFA , CFP

What is the inflation rate that comes to mind when you think of inflation?

For most, it’s often the rate that’s published by the respective government agencies in different countries.

We know this as the consumer price index (CPI). We often see this as a single digit number.

But is this the real inflation that impacts our lives?

Your real inflation is a function of the lifestyle you live. Therefore, an important concept to understand is lifestyle inflation.

Lifestyle inflation refers to the increase of one’s spending when income goes up.

From a personal finance perspective, individuals should be aware of lifestyle inflation, as it can erode the ability to save and invest for the future. Investors may consider the impact of their own lifestyle inflation when planning for retirement or other financial goals. This involves ensuring that their investments at least keep pace with the rate at which their expenses are increasing, so they don’t lose purchasing power over time.

Inflation rates (the general rise in prices across the economy) should be a component of the investment return in the sense that investors often seek returns that exceed the rate of inflation to maintain or grow their real purchasing power. In this context, if an individual’s lifestyle inflation consistently outpaces general inflation (which is often true for most people), they should indeed aim for a higher return on their investments to sustain their accelerating cost of living. However, this higher required return should reflect personal financial planning.

The key is for investors to earn a real rate of return (after inflation) that allows them to reach their financial goals while maintaining or improving their lifestyle (and standard of living).

What inflation rate are you factoring while making long-term investments?