Merriam-Webster defines inflation as the continuing rise in prices, usually caused by an increasing volume of money in the economy. This means that purchasing power decreases over time. Gas and groceries are time-tested examples. In the 1950s, a gallon of gas or a loaf of bread cost under a dollar. Now, a dollar simply does not buy the same volume of goods as it used to.
Inflation can, unfortunately, be considered an inevitable part of the economy. This is one reason that as financial advisors it’s crucial to look at assets that we can consider “inflation-proof,” at least to the degree that inflation-proofing is possible.
While a static savings account can’t exactly outpace inflation, there are actually two assets that do “perform” better because of inflation: real estate and life insurance.
How a Mortgage Can Benefit from Inflation
In our Prosperity Proof #2 post, we broke down why a 30-year mortgage can actually be more beneficial from a savings standpoint. Yet there’s another long-term reason that a 30-year mortgage can assist in your client’s overall savings objectives. The secret is in level payments.
A level payment means that the monthly mortgage payment will always stay the same. On the surface, that means it won’t get more expensive. If we dig a little deeper, we can see that over time, a mortgage can also feel less expensive.
Consider a $250,000 home in today’s market. At a rate of 3%, a 30-year mortgage will have a monthly payment of $1,054 and some change, while a 15-year mortgage is going to have a monthly payment of $1,726 and change.
Note: All calculations shown below are accomplished using Truth Concepts version 3. 00.0.05.
If inflation drives home prices up over time, a mortgage will freeze that in place and give you a level payment. If you pay $1,054 now on a $250,000 house, in 30 years that $1,000 is going to feel like a lot less. In fact, it’s going to have the same impact as $429 if we expect prices to inflate at about 3%.
Explaining “Present Value”
We can conclude this using the Present Value calculator. The reason we use the Present Value Calculator is to because we’re imagining the $1,054 mortgage payment as a Future Value.
So the level payment out in the future will still be $1,054. Using the Present Value Calculator allows us to imagine what that same payment will feel like in today’s dollars, 30 years out in the future.
To calculate, you’ll take the future payment, at an inflation rate of 3%, over 360 months. Be sure to change the format of the calculator to “End” and “Monthly,” as shown.
The result is a mortgage payment that feels like $429 in today’s dollars.
How Inflation Impacts the 15-Year Mortgage
For comparison’s sake, we’ll give the same treatment to the 15-year mortgage. This time, we’ll see how that payment feels at the end of 15 years or 180 months. The result is a payment that feels like $1,101.
Banks Lose Value on 30-Year Mortgages
You have to wonder why banks encourage 15-year mortgages by offering lower interest rates if they stand to make more money by earning higher cumulative interest. This inflation secret is one distinct reason.
The longer the bank waits to get their money back on the mortgage, the less power those dollars actually have. A shorter mortgage time frame gives the bank as much value as possible. They don’t want $1,000 with the impact of $400 if they can get something better.
The cumulative interest people pay on a 30-year mortgage is simply a fun fact. Holding on to a home with a payment that decreases in impact is likely to your client’s benefit. And as you’ll see in our Prosperity Proof #2, there’s a difference between cumulative interest and the actual opportunity cost of a 15-year mortgage as opposed to a 30-year mortgage.
The Impact of Inflation on Life Insurance
Just like a mortgage has a level payment, so too does life insurance. Whole life insurance, to be exact, has level premium payments. This means that over time, your client’s premium payments are going to feel like less and less.
A $5,000 premium, for example, paid over 99 years, is going to feel like $267.97 in today’s dollars. That’s a significant impact over time.
Your clients may think—doesn’t inflation also reduce the value of my Cash Value and Death Benefit over time, too? While this is true, as all money is impacted by inflation and time, whole life insurance is also designed to keep up with and potentially outpace inflation.
Historically, life insurance policies out-earn a typical bank savings account. In a low-interest-rate environment, this can change. However, life insurance companies also have a track record of paying dividends even in low-interest-rate environments like wars and recessions.
The result is an even better ROR than a bank savings account, with greater certainty than an investment or correlated asset. Combined, you have a vehicle with staying power, that has inflation benefits beyond a level premium.
Master the Financial Calculators
You can illustrate these same principles by downloading a free 10-day trial of Truth Concepts today. And to take your understanding even further, we invite you to attend a live, 3-day Truth Training event. You’ll learn how to use all the Truth Concepts calculators with confidence and competence.