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How quickly does inflation reduce purchasing power? Here is a simple guide

 How quickly does inflation reduce purchasing power?  Here is a simple guide

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Inflation is hovering around 40-year highs. The consumer price index, a key indicator of inflation, increased in April by 8.3% compared to the same period last year. since the summer of 1982This was announced on Wednesday by the US Department of Labor.

Despite a slight decline from 8.5% in March, the testimony tells a similar story: consumers are losing purchasing power faster than usual.

This is because the prices they pay for goods and services of all kinds are rising. Their money buys less.

But how fast does inflation eat away at your savings? “Rule 72” can help assess its long-term impact.

Rule 72

This rule usually applied to return on investment. This is a calculation that roughly shows how many years it will take investors to double their money at a certain interest rate.

Here’s how it works: Divide 72 by the annual interest rate to determine the amount of time it takes to double your investment.

For example, the mutual fund, which yields 2% per year, will double in 36 years. One with an annual income of 6% will do so in 12 years.

With inflation, the rule works the other way around: consumers can roughly estimate how quickly higher prices (for food, energy, rent, and other household budget items) will halve the cost of their savings.

When applied to formula 72, April inflation of 8.3% halves the value of consumer money in about nine years. (Seventy-two divided by 8.3 equals 8.67.)

“[The rule] works the same if you mean the inflation factor – which essentially reduces the purchasing power of your money – or you apply rule 72 to increase your money, “- Charlie Fitzgerald III, certified financial planner and founding member, CNBC’s Maysand reported. Fitzgerald Tamayo in Orlando, Florida.

What to keep in mind

However, there are a few caveats.

First, this rule assumes that inflation will remain elevated (and constant) for some time. It is unclear how long inflation will remain above normal. The Federal Reserve is rapidly raising its benchmark interest rate to increase borrowing costs, cool the economy and further control inflation.

A healthy economy is experiencing at least some inflation. The Federal Reserve is aiming for a long-term rate of about 2%. (This inflation rate would halve the value of money in about 36 years, according to Rule 72)

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In addition, rising costs do not affect all households equally. In some families, personal inflation rates may be lower (or higher) than the national average, depending on what they buy.

Rising wages and wages on savings also serve to offset at least some inflation. Workers saw an increase in hourly wages the fastest pace in decadesand some achievements have outpaced inflation, meaning that their purchasing power has not diminished.

However, in April, adjusted for inflation, hourly wages fell by 2.6% over the same period last year, according to the Ministry of Labor.

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