Note: The CPI is a Bureau of Labor Statistics (BLS) tool that strives to measure and track inflation. It evaluates the price change in several essential consumer goods and services such as utilities, food, fuel, etc.
According to Merriam Webster, the definition of inflation is “a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.”
Is inflation equal to a pay cut?
Indirectly but significantly, inflation might be equated to a person or family experiencing pay cuts. Inflation diminishes the buying power of money.
Example: John Snow was earning $50,000 in 2021 when his employer gave him a whopping 4% pay increase. However, during the next 12 months, inflation goes up 8.5%, meaning the costs of living for John went up 8.5%.
John started with $50,000 + his $2,000 ($50,000 x 4% = $2,000) raise which allowed him an income of $52,000 ($50,000 + $2,000 = $52,000). However, that 8.5% inflation meant that for John’s income to keep pace, he would have needed a $4,250 ($50,000 x 8.5% = $4,250) raise to keep pace with inflation.
So, John’s real financial position saw him experience an annual $2,250 deficit ($4,250-$2,000 = $2,250). Therefore instead of a livelihood that put John $2,000 ahead for the year, John struggled even more. His buying power has diminished by $2,250. The buying power of his pay was essentially cut to $47,750 compared to 2021. ($50,000 + $2000 – $4250 = $47,750).
Inflation, the killer of currency
As inflation plows ever forward along its destructive path, it minimizes currency’s value. In doing so, it periodically causes the demise of the lowest hanging tender.
Death of the Mil
It may be hard to imagine anything worth less than a penny today. However, according to US Coin Value Advisors, the ½ a penny (or 500 mills or mils) was one of the first two coins printed in the newly formed US under the Coinage Act of 1792.
A mil is a currency unit worth 1/1000 of a dollar (the dollar is considered the base US unit of money) or 1/10 of a penny. US Mints didn’t produce mils (units smaller than ½ a penny), but some state and local governments did. They were of cheap quality, usually made of plastic, tin, or even paper.
Fun fact – A single mil in 1800 would be worth about the same as 2.3 cents today. (Based on CPI Inflation Calculator)
Fun fact – A ½ a penny in 1800 would be worth about the same as $11.60 today. (Based on CPI Inflation Calculator)
By 1960, virtually all mil production had ceased in the states. Inflation had deemed them no longer necessary. A mil valued at less than a penny was more trouble than it was worth.
The Importance of Budgeting
In my experience (within my practice), it seems evident that when someone retires, they begin to learn how to budget their finances and resources effectively (a fixed income can be a fine motivator).
However, until then, many of my clients admit that they didn’t focus on a “budget” or firm budgeting principles.
Cash Poor (Not his real name) is a long-term federal employee who had plans to retire near the end of this year (2022). Cash’s wife (not a federal employee), Penny (not her real name either), is also looking to retire during 2022. Both have significant retirement savings that have been hit hard these past several months. They report that combined, their retirement savings are down approximately 18% year-to-date (YTD).
As their planned retirement drew near and a realization that their retirement savings and self-designed retirement plan may come up short of their needs, they thought it prudent to schedule a Retirement Readiness Review.
During that review, the subject of budgeting came up. Unfortunately, the Poors didn’t have a structured budget. They merely had a philosophy (albeit a good-sounding philosophy) of “let’s not spend more than we make.”
Even THAT philosophy had holes in it. One way the Poors would adhere to their philosophy was by using credit to spread the debt over a long period. But of course, that meant they were keeping less of their earnings due to interest rate charges…not a great budget plan.
We discussed a few budget strategies that could help them coordinate the effect of rising interest rates, pay off interest-heavy credit items, and save for goals they were looking forward to in their retirement years.
Good Budget Planning Options
There are many good and bad budget plan options. Here are just a few of the good ones:
1. Slip Budgeting
When I was a young man, this was pretty popular among my peers. The idea is first to recognize how much was needed for each “mandatory” item (i.e., Rent, utilities, car payment, credit cards, etc.).
Next, separate weekly or bi-weekly income and “slip some into each item until you have reached your monthly goal.” We often used labeled envelopes or file folders to separate, slip, and store our cash until it was time to pay each bill. Any excess was ours to use as we wished…a step into adulthood for sure. We were able to decide how to utilize that excess without fearing voiced consternation from our parents.
Probably the next logical step in budgeting methodologies. This option seems to be fairly popular today with feds I meet. You know the principle of this (maybe you heard it called the spreadsheet) budgeting technique. Instead of a file folder or envelope, a spreadsheet categorizes each budget item.
During a Federal Retirement Readiness Review, this is one of the pointers we often give budgeting beginners. When using the spreadsheet budget, start with a baseline…what things cost right now. First, add the total expenses for the past 12 months of bank statements. Then subtract significant one-time expenses and add any known additional expense that can be anticipated moving forward. Now divide that number by 12. This will give a projected monthly expense for future budgeting.
From there, the budgeter can return to those bank statements and create categories on their spreadsheet as they see fit.
If they stick to the budget each month, they can anticipate how much they will spend on each item. They can also account for inflation by adding known inflationary figures.
3. Percentage Budgeting
This is another good budgeting beginner route. It allows you to decide how much you want to put aside for broad categories. Perhaps you want to split your dollars into three simple categories – Necessary bills, your wants, and savings/debt reduction.
Of course, necessities must be covered, but provided your income allows, you may determine that a 60/20/20 percentage works best for you. 60% necessities, 20% wants, and 20% savings/debt reduction.
Virtually any percentages could be applied in each percentage bucket — as long as necessities are always accounted for first.
Depending on the federal employee’s situation, we may discuss one of these budgeting options or some other budgeting plan. The idea is to get federal employees to think about and implement budgeting. In today’s environment, it may be more important than ever for virtually everyone.
Budgeting could teach better money management, restraint, patience, focus on financial goals, recognition of where one’s money is going, and be better prepared for unforeseen expenses — or out-of-control inflation!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risks, including the loss of principal. No strategy assures success or protects against loss. Silverlight Financial, Infinity Financial Services, and its affiliates do not provide tax, legal, or accounting advice. This material is not intended to provide and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. For a list of states in which I am registered to do business, please visit www.silverlightfinancial.com.