I saw this headline recently and immediately started to predict all the reasons the writer was going to enumerate about the benefits of investing. Yes, we all have seen those listicles that make great clickbait about the "10 Reasons You Better Invest!" Instead, the writer surprised me with a one word answer that everyone can understand: Inflation. Read on to find out why inflation matters...

From Monevator: 

This graph shows how what you can buy with £10,000 falls over the years, due to the impact of inflation. Inflation is the tendency for the cost of things – bread, houses, wages – to rise.

As such it reduces the spending power of your money each year.

• In 25 years time, you will still have £10,000 in nominal terms. Your twenty £500 notes will still be under your mattress, and the Queen of England will still be frowning at you.

• But in real terms the spending power of your money will be diminished.

The graph shows the impact of just 2% annual inflation on your money. 2% reduces the value of your money by only a little bit each year, but it adds up to a 40% loss in real terms over 25 years.

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Why does this matter? Young people are often fearful of the "risk" of investing in stocks. They don't often think about the "risk of losing purchasing power" by keeping their money in "no risk" savings account (with FDIC insurance) earning almost 0% interest. While 2% inflation may not seem worthy of concern (so what if a loaf of bread goes from $3.00 to $3.06?), the compounding effect leads you with 40% less purchasing power (in real terms) over a 25 year period. Would you ever choose an investment that would leave you 40% poorer in 25 years? I didn't think so. That's why we invest. To earn returns in excess of inflation (stocks have returned 8-10% per year over the long-term) so you have MORE purchasing power in the future and not less.

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For more on inflation, check out this NGPF Activity: Analyze: Understanding Inflation

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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