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Inflation: How the industry gets it wrong

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Why do traditional retirement plans offer a false sense of security? Because they benchmark their performance against inflation.
 
►What is inflation?     
 
Inflation is measured by what is known as the consumer price index (CPI). CPI basically represents the cost of a basket of goods and services used by a typical or average household.
 
The change in CPI from one period to the next can be used to work out the inflation rate. CPI thus measures the rate at which consumer prices increase in an economy and is synonymous with the change in cost of living.
 
For example, suppose a typical household in South Africa consumes four loaves of bread at R4 each and two bags of potatoes a R10 each. The total cost of the basket is R36 (4*4 + 2*10) in year 1.
 
Let’s assume in year 2 the price of bread increased to R4.50 and the price of potatoes increased to R11. The total cost of the same basket of goods is now R40 (4*4.5 + 2*11).
 
The inflation rate will therefore be reported at 11.1% (40 – 36 / 36 *100).        
 
►How is inflation sold to investors and the public?
 
Fact 1: CPI is used as a measure for the cost of living. As a result, people are encouraged by experts to seek returns which at the very least match the inflation rate (and rightly so!).
 
Fact 2: Financial institutions focus their marketing efforts on products which tend to outperform inflation. Investors are therefore ‘trained’ to benchmark the success of investment products against the cost of living. 
 
►Why does this thinking offer a false sense of security?
  • CPI provides a picture of the expenses of an average household. Do you live in an average household? Your spending pattern may be significantly different.
  • Inflation has absolutely no bearing on your personal lifestyle needs. Keeping up with living costs is one thing, but generating income to support a specific standard of living is something completely different.
►The truth
 
There is a massive difference between a return which beats inflation and a return that enables you to achieve your desired standard of living.
 
In actual fact, they are worlds apart.
 
If your goal is financial freedom, returns benchmarked to inflation are just not good enough
 
True wealth creators ignore CPI all together. They focus on generating sufficient passive income to support their ideal lifestyles. 

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