The Trap in Calculating Inflation Rates Over Multiple Years

You have to be wary of making math mistakes with long-term inflation.

May 31, 2015 at 10:15AM

Inflation is one of the biggest enemies of long-term investors. But to get a handle on its true impact, you have to make sure you calculate it correctly not just month to month or year to year but over history. Let's look more closely at the correct way to measure long-term inflation.

Why inflation matters
The inflation rate measures the change in prices. As prices rise at a faster rate, the inflation rate is higher and each dollar has less purchasing power.

Measuring the inflation rate can help you predict how prices will change in the future and help you budget accordingly. When calculating the annual inflation rate over multiple years, you must account for the effects of compounding interest, so you may not simply divide the total inflation rate by the number of years.

The 4-step process to get inflation right
Fortunately, it's not hard to do inflation calculations. You can typically use this simple four-step process.

First, divide the price at the end of the period by the price at the start of the period. For example, if you wanted to measure in the annual inflation rate of gas over eight years and the price started at $2.10 and went up to $3.60, divide $3.60 by $2.10 to get 1.714285714.

Second, divide 1 by the number of years over which inflation takes place. In this example, divide 1 by 8 to get 0.125.

Third, raise the overall inflation rate from step 1 to the power of the result of step 2 using a calculator. Raising refers to using exponents. In this example, raise 1.714285714 to the 0.125th power to get 1.069696071. With a calculator, enter "1.714285714," push the exponent key (usually denoted with a "^" or a "x^y"), enter "0.125" and then push the equals key. When raising a number to a power less than 1, you get a number smaller than the original.

Finally, subtract 1 from the result to find the annual inflation rate. In this example, subtract 1 from 1.069696071 to find that the annual inflation rate equals 0.069696071, or about 6.97%.

This process might seem longer and more complicated than necessary. To avoid costly mistakes, though, this method will get you to the right long-term answer in evaluating inflation.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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