Inflation and Bonds
Way back in 1799, poet William Wordsworth decided to rent a cottage in the Lake District of England. His rent? Under $8/year.
Today, when an apartment can cost you $2,500/month, it kinda makes you want to slap him, doesn't it?
The culprit is inflation, or the gradual increase of prices and wages over time. If your granny complains about the cost of milk and bread today and reminisces about the good ol' days, she's actually fretting about inflation. Well, that and the fact that she had to walk uphill both ways.
It's 2024…Do You Know Where Your Bonds Are?
So what does inflation mean if you have bonds?
Well, it can be bad news.
If you buy $1,000 in bonds and hold onto them for ten years, making 8% each year, you're going to be earning about $80 per year. At the start of those ten years, $80 might buy you a nice dinner. After ten years, though, that $80 might only buy coffee and dessert. When your bond matures at the end of ten years and you get your $1,000 principal back, that $1G will be worth a lot less than when you invested it.
The news is even worse if you, like many people, are looking at bonds to make money for when you retire. Let's say you sock away a million dollars for your retirement. If you find bonds that have an interest rate of 8% you might be getting $80,000 a year. Not bad.
Let's say that when you retire, the average income is $50,000, so you're well above that and are able to enjoy snorkeling and gourmet fudge-making classes at your local community center. But you live for twenty more years. After two decades, the average income is more like $150,000 and everyone commutes to work in flying space pods. Now that $80,000 doesn't take you very far at all. It might only pay for knitting classes at the Y—and you might not have enough for the yarn.
Inflation is just one of many reasons you'll need to save more than you think for retirement.
Inflation Can Warm a Cold Capitalist's Heart
Inflation isn't all bad.
If you're the company issuing bonds, it's downright fabulous. Let's say you issue $10 million in bonds at 8%. In the first year, you might scrimp and save to pay the interest on those bonds. But then ten years go by. Your company has doubled in size and so has everything else. Milk that used to cost $2 a gallon now costs $4 and your salary has jumped from $200,000 to $450,000 (you are CEO, after all). It's a snap to pay the $800,000 in interest on those bonds now, and you're laughing all the way to the bank (or the steak house—you have a date at 6:00).
Inflation can be good or bad, depending on how you look at it. But it is going to affect your investments; so if you are investing for the long term, make sure you take it into account.