Cash: The Loser’s Game


If you haven’t noticed, I have a bit of an obsession with inflation (evidence here, here, and here). It is my greatest fear as an investor. I found some old one dollar bills from back in 1973. I knew it was time for another lecture on the dangers of inflation. I’m going to explain what Cash: The Loser’s Game means.


Thought Experiment

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Let’s conduct a little thought experiment. Let’s say Johnny and Sally each received a one dollar bill back in 1973. Johnny, being a bit aloof, promptly loses and forgets about his one dollar bill in his closet. Sally, being rather intelligent and shrewd, invests her one dollar bill into an index fund tracking the S&P 500 for the full 41 years. 41 years later, who’s come out ahead?

Johnny is Poor

Inflation 1973-2014

In the year 2014, poor little Johnny and his one dollar bill is still worth exactly one dollar. But there is a painful catch: not only is it still only worth one dollar after 41 years, it has actually depreciated tremendously in terms of purchasing power.

Poor Johnny could have bought $5.38 worth of goods back in 1973 with that one dollar bill. Today, he can only buy $1 worth of goods. That one dollar bill, sitting in the closet for 41 years saw a 438.03% change in its purchasing power, with inflation eroding purchasing power on average 4.19% annually.

Sally is Rich

Screen Shot 2014-08-10 at 1.56.54 PM

Meanwhile, Sally has seen her one dollar grow to $55. Her one dollar in the S&P 500 index fund has grown at an average annual rate of 10.29%. Not only has her money grown astronomically, it was able to outpace the average annual rate of inflation of 4.19% during the period.

After adjusting for inflation, Sally’s investment in the S&P 500 index fund saw a real annual growth rate of 6.1% (10.29% – 4.19%). The inflation adjusted, real purchasing power growth saw her one dollar bill grow to $10; this means that, after accounting for the erosion of inflation over 41 years, her one dollar has really grown to $10.

Yes, it can be a little confusing and a bit of a mind bender, but the most important take away is that Sally saw her money grow. Substantially.

Inflation: High, Medium, Mild

When I was graphing the inflation numbers through the Bank of Canada’s Inflation Calculator, I noticed some interesting trends with inflation over this 41 year time span.

First, allow me to draw your attention to a period of high inflation in Canada:

Inflation 1973-2014 - High Inflation

This is the period our parents and grandparents talk about: the era of high inflation and high interest rates. Isn’t it pretty unreal that the purchasing power of that one dollar bill lost over half of its purchasing power in a 9 year span?

Did you know that the last real estate market correction in Vancouver occurred during this period. Why?

Because many people who were over-leveraged in the real estate market suddenly saw their monthly mortgage payments skyrocket as interest rates rose with the high inflation rates. As mortgages came up for renewal, many people could not afford the monthly payments on the new, higher interest rates they needed to pay, especially if they were leveraged to the max. Many people simply handed the bank the keys to the homes they could no longer afford and walked away.

Now, let’s move onto a period of decelerating inflation:

Inflation 1973-2014 - Medium InflationThat’s not too bad, huh? 4.58% inflation sure as hell beats 9.98% inflation. Inflation in the early 1980s to early 1990s started decelerating from the rather insane levels of the 1970s to early 1980s.

And ever since, we’ve been rather blessed with a long stretch of mild inflationary rates:

Inflation 1973-2014 - Mild Inflation

Caveat Emptor

Just because we’ve enjoyed a rather tame and mild stretch of inflation doesn’t mean that this will always be the case. Inflation can spike anytime. No one expected such high levels of inflation in the 1970s and 1980s, but that didn’t stop inflation from ravaging savings and purchasing power. Serious investors must always remain vigilant and wary of inflation.

The erosion of purchasing power through inflation is terrifying. Terrifying because it occurs so silently and meticulously. Think of what gas cost back 20 years ago. What? Maybe like 50 to 60 cents a litre? What does it cost now? Maybe like $1.40 a litre. There’s inflation for you.

I try to combat inflation through a variety of means:

1) By always using credit cards for their rewards points

2) Only holding cash in true high interest savings accounts

3) Avoiding sneaky investment fees

4) Investing in the stock market

Is it just me or do you fear inflation as much as I do? How do you combat inflation?

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6 thoughts on “Cash: The Loser’s Game

  1. Another great article on inflation!

    You really seem to fear inflation a lot more than I do. Maybe because my salary and all government spending in Belgium is automatically adjusted for inflation? I only have to make sure that my current savings keep up with inflation.

    Most of my savings are therefore in stocks. The chance of the stock market not beating inflation for a longer period of time is really slim, otherwise there’s something seriously wrong with the economy.

    On the housing issues in the 1970’s: we saw something almost the same over here, but to most people with a mortgage the inflation was a godsend. While they had an interest rate of over 10% on their loan, that rate was fixed. So after a couple of years they were basically paying off less and less each month because their salaries automatically went up with inflation. Especially if you are in debt inflation can be a positive force!

    1. Haha I see it like high blood pressure: the silent killer. I wish we had wages and government spending over here automatically adjusted for inflation, but it’s not so it makes it a little more worrisome.

      I’ve heard the flip-side of the high inflation era that you mention. The people who were locked in for 25 year fixed mortgages saw a boon, like you state, because they were fixed into a lower interest rate while their wages rose with inflation, allowing them to pay off their debts faster. It just sucked for the people who locked in for short term fixed rates or variable rates – they got absolutely crushed, especially if leveraged to the max!

  2. I am concerned about inflation as well, but I don’t think about it quite as much as you do 🙂 My biggest thing is that my brother-in-law thinks he’s got it made for the rest of his life because his workplace financial advisor told him how much money he’d have in 20 years (he’s 40 now). It isn’t especially impressive in my mind, but even less so when you think that that’s 20 years of inflation to eat up. Back in 1994 even I remember the difference in costs. I wish I could wake him up to it, but in his mind a six figure retirement account sounds cushy…

    1. Haha I am a little obsessed, but I really think it is one of the greatest dangers to wealth.

      It’s too bad people aren’t more aware of economic history, especially inflation history. Being a millionaire today does not carry the weight it would have back 50 years ago. Even a $1,000,000 portfolio might not be enough by the time Gen Y retires for a “traditional” retirement.

  3. I actually don’t think about inflation at all, but I keep coming here for all the pretty pictures on money 😉 So cool how different it all looks across the world.

    1. I swear I remember seeing somewhere on your blog that you think about inflation all the time 😛

      The money might all look different but the trend it all takes is the same: depreciation 😉

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