Question

Social Security is indexed to protect against inflation(there is a COLA tiedto the CPI), private retirement accounts would not be able to guarantee this protection. why is important to protect agains inflation?

Answer 1

• inflation implies increase in prices where the purchasing power of consumer increases and there is competition among consumers to buy product particularly due to limited supply.
• where inflation represent increased purchasing power of consumers there it also represent that the purchasing power of currency has declined and the value of currency does not remain same over time.

protection against inflation is very important and we can understand this concept with the following example-

• suppose Jack has $200000 as saving he split this amount in two parts and deposited the first part in bank which would yield him 6% per annum and remaining amount he kept in the house safe.
• after 5 years Jack received a total amount of $134685 including interest that means he earned an interest of $34685 now assuming the inflation has been increased in five years by 8% that means the amount $134658 is worth of $123910 only.
• but the amount kept in the locker is $100000 in monetary term but if inflation rate is deducted then the amount would be equal to somewhere 92000 this means inflation has reduced the value of $100000.

in the above example we can understand why it is important to protect the investment and wealth against inflation and furthermore we need to generate return over investment which would be more than the rate of inflation.