Please tell me. How many burgers can I buy today?

Nope. Although it sounds like it but this isn’t a post about being poor and happy or self-contentment and all the hokey-sounding stuff. It’s not that those aren’t important but today, I want to write about a topic that is equally important but also grossly misunderstood; and of course, it fits within my realm of knowledge. (Self-contentment is, unfortunately, something I have to work harder at.)

What I want to write about today can be summarised (as Warren Buffett famously did) in one sentence: It’s the number of burgers you can buy today that matters.

The official name, as economists and financial experts call it is ‘Purchasing Power’. For example, let’s say you were earning $100 dollars a week 50 years ago and then the price of a hamburger was $1, are you better off today if you are earning $1000 dollars a week but the price of hamburgers is $10? The answer obviously is no. You should be equally satisfied unless your hamburger preferences change (econo-geek speak: marginal utility).

Economists and Statisticians try to capture this effect of rising prices in a concept called Inflation (the measure is Core Price Inflation or CPI) but the measure of course cannot be applied to individuals since none of us consume exactly the same basket of goods with the exact weights used in the measure. Take the chart below for example:

Table 3. Nominal and Real average monthly household income series

Although real household income has risen by 0.3% from 2009 t0 2010, why do some people feel worse off? That’s because the CPI deflator does not capture the full effect of the price increase for every single individual. Lower income residents feel the impact of rising transport and food prices greater but the weights in the CPI basket of goods do not reflect as such. A simple look at the difference in CPI for different income brackets will suffice (here).

The bigger point to note is that Inflation is a very real phenomenon and its impact on our financial health should be at the forefront of our minds. For example, Mr Andy Lim is a regular office worker, earning a decent salary. He doesn’t know much about investing and is looking to preserve his wealth. Interest on Savings Accounts offered by Singapore banks are at a measly 0.25% but hey, these accounts are covered by deposit insurance so even in the event the Bank goes bust (unlikely due to quite stringent financial regulations but that’s another issue) so Andy Lim decides to park his savings there. Is he getting a good deal?

Unfortunately, with the historical rate and likely future path of the rate of inflation, the answer is  no. In fact, savers like him are being penalised because the dollar value on his savings are being eroded due to the low-interest rate on his savings. A negative real return due to the effects of inflation means that Andy Lim is actually better off spending the money since he can buy more hamburgers today than in the future.

The prices of goods is merely illusionary; If your plate of chicken rice goes up from $2.50 to $3.00, but you can actually afford to buy twice as many plates of chicken rice today as compared to 10 years ago, you are actually better of. Think in terms of burgers or Chicken rice.

The mini lesson to be learnt is Saving is not always a smart thing. You have to account for the after inflation rate of return.

Key principle to take away from this? Inflation matters.