Inflation adjusted value

Photo by polckadot

When you see a number in an old book have you ever been flabbergasted at how low that number was? I was reading a book and there was a point where a piglet cost 50c and I was trying to figure out how it could be that cheap. Well the thing is those books were written a long time ago and over time that long time increases how much things cost. So how can you compare these prices over time? That is where you adjust something for inflation.

Inflation is typically considered to be 3% so it's just taking a number and doing a bit of compound interest on it.  Where it gets interesting is when you compare values from the past and present to values in the future.

Lets say your looking at a house in 2000 and you see back in 1990 it sold for 50,000 dollars and now they are wanting 100,000 is that a reasonable amount?

Year	Amount	Inflation Rate
1	50000	0.03
2	51500	0.03
3	53045	0.03
4	54636.35	0.03
5	56275.44	0.03
6	57963.7	0.03
7	59702.61	0.03
8	61493.69	0.03
9	63338.5	0.03
10	65238.66	0.03

Well it's going to come down to if they updated the place, added a new roof (15k) or did some other updates but inflation alone doesn't account for the amount of money being asked for.

So basically what we are doing is taking 50,000 dollars in 1990 and see what amount of money would be necessary to buy the same amount of 'stuff' in 2000. This is the same formula as compound interest.

One key thing though is that sometimes you see money outlays like Buy this new car for 30,000 dollars over 5 years with 0 percent interest  vs Buy this used car for 20,000 dollars. At first glance it seems like a simple 10 k difference but it is actually a little bit different than that.

Just from basic inflation that 20,000 dollars in 5 years is:

Year	Amount	Inflation Rate
1	20000	0.03
2	20600	0.03
3	21218	0.03
4	21854.54	0.03
5	22510.18	0.03

So its still cheaper but it's not 10k cheaper. Also that 30,000 dollars isn't given to them all at once. So even if your giving them 6k a  year that 6k buys less stuff each year.

Year	Amount
1	6000
2	5820
3	5645.4
4	5476.038
5	5311.757

The new car dealer would get the buying power of 28,253.2  dollars in today's dollars. If they are trying to make you 'buy' this opportunity from them look at what your getting.

You will see all sorts of offers based on straight line math when compound interest is in play. 

If you buy these windows for 15,000 dollars it will save you 100 dollars a month in energy expenses which is 1200 dollars a year so it will take 12.5 years to pay it off. Well that's not taking into account inflation.  Your not really saving 1200 dollars a year, inflation accounts for 450 dollars a year (15,000 *.03) so when you do the math you want to use 750 dollars not the 1200 dollars the vendor is feeding you.

This is why you see the 4% withdrawal rule is really using a 7% return on an index fund. 4% is for you and 3% is for inflation.