Price inflation is like boiling a frog. In this rather unpleasant analogy, the frog is placed into a pot of cold water, and the water is gently warmed. The frog doesn't notice the temperature slowly rising, until eventually it gets so hot that he dies. Compare that to trying to get a frog into the hot water - he'd jump straight out again.
The same goes for inflation. If someone suddenly doubled the price of a packet of biscuits, you can be certain you'd spot it - and complain loudly - but when that price rise comes slowly over a period of years most of us have no idea the price has changed at all. So can you guess just how prices have changed over the years?
Provident Personal Credit has created a quiz, which invites you to have a stab at guessing the price of things in various years, and some of the results are staggering. The 'Back in the Day' quiz, for example, asks how much a pack of razors cost in 2009 (bearing in mind that they are £8.49 today). The answer reveals that the price has more than doubled in five years - because you got more razors in the packet and they were priced at £5.
It also asks about house prices - taking the fact that the average house price in 2013 was £247,000, and asking what it was 14 years earlier. The answer is that prices have gone up 165% in that time. This is particularly striking given that this included a particularly turbulent time for house prices after the financial crisis.
The results go to show that despite all the talk of inflation falling in recent months, prices are still going up, and the cumulative effect remains dramatic.
Most people massively underestimate the effects of inflation, which has two major implications for our ability to manage our money.
The first is one of the reasons people go into debt. Because prices have gradually risen without us noticing, we haven't changed the way we budget for these expenses. This may be deliberate budgeting, or the quick mental accounting we do when we get our pay packet and are trying to work out how much we can afford to spend on a new pair of shoes.
Between 2007 and 2014, for example, the average price of food rose 12%. Assuming that back in 2009 we were spending £90 a week at the supermarket - by now we would be spending £110.08. If we aren't paying attention, then we're over budget by £10.08 a week or almost £525 a year.
When you apply this to every area of your spending, it's easy to see how gradually increasing prices can lead to accidental overspending.
The second implication is that we massively underestimate our income needs in retirement. If, for example, a 30-year-old was to make a rough calculation of the annual income they needed in retirement, they might think they'd need about £18,000. However, if they ignored inflation, and worked towards this goal, they'd be in for a horrible shock.
Assuming a retirement age of 65, life expectancy of 85, and annual inflation of 3%, in order to have an equivalent sum on the day of their retirement (taking inflation into account) they'd need £50,650 a year, and in the year of their 85th birthday they'd need £91,479. You can see how £18,000 would be a drop in the ocean.
It's vital therefore, to keep an eye on inflation, and understand what it means for you. It's difficult to do this over the long term, so the best approach is to take stock every year. January is as good a time as any to put some time aside to calculate what you are actually spending in each area of your life - as opposed to what you think you are spending. That way, if we go back to the ill-fated frog, we can make ourselves aware of the temperature as we go along, and take appropriate action.
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