In case your school forgot to include this in a financial education lesson plan, we’ll introduce COLA to you right now. COLA is an acronym that stands for Cost Of Living Adjustment and is an annual figure calculated by the government that measures how much inflation has gone up in the past year. But we don’t care about inflation, right? It doesn’t really have an effect on anything. Wrong. It has everything to do with your purchasing power and ability to create wealth through investing.
Assume that each year brings at least some amount of inflation, which causes a decrease in your purchasing power. For every rise in inflation, there is a corresponding drop in the value of a dollar. That’s why the idea of the COLA is critical to those living on fixed incomes, like retirees. But how does the COLA apply to a young whippersnapper just out of school?
Pay attention. Here comes another financial education lesson plan that was probably neglected by your school. It has to do with investments. At the end of the year, when you add up your total return on investment, it had better be higher than the COLA or you’re not making any money at all. Here’s an example. The government reports an annual increase in inflation that is usually around 5%, a laughable number, in our humble opinion. We believe it’s more like 10% or maybe even higher.
The point is that if you have a mutual fund that performs at a decent rate and returns about 10% per year, you’re only breaking even. Yes, the number of dollars in your account might be increasing but, in terms of purchasing power, unless you’re making more than the real inflation rate of 10%, you’re not coming out ahead. You’re actually losing money by investing, even if it shows a profit on paper.
What you need is an investment asset that profits in the face of inflation. Don’t think it exists? Wrong. Real estate investors who employ an income property strategy correctly could see annual returns in the 20% to 30% range, a high enough level to overcome inflation.
The Young Wealth Team
Flickr / Stefan