In this blog I talk about the fun topic of inflation!
Why have I written a blog to help parents teach their kids about inflation?
Most people don’t fully appreciate the impact of inflation and I want the next generation to be fully aware;
It’s very topical at the moment as inflation has suddenly spiked and there's some fear it could increase further;
Hopefully this will encourage a few of you parents reading this to start investing your kids' savings.
If your kids love McDonalds, then they are going to love learning about inflation based on the examples in this blog. I have used McDonalds throughout this blog for 3 reasons:
To be consistent with the example I used when teaching my girls about investing (see this blog)
Using a real-world example makes it more engaging for kids to understand new topics
We miss McDonalds, we haven’t had one since 15 January 2020 due to COVID ☹️
[I’ve used US dollars in this blog as it was easier to get the price of a Big Mac at different dates in dollars]
How to teach your kids about inflation
Let's start with a little quiz:
QUIZ: If you had $100, how many Big Macs do you think you could buy?
In 1981 (40 years ago)
In 2021 (today)
In 2061 (40 years into the future)
Scroll down for answers ⬇️
* Assuming 2.5% per year increase in price for Big Macs in dollars from 2021 to 2061
As the price of Big Macs goes up over time, the less Big Macs that $100 can buy.
My kids thought I was really lucky that Big Macs were so inexpensive when I was young. I had to tell them that whilst things cost less then, people also earned a lot less money. Later I showed them how many Big Macs they could buy in the future if that $100 was invested ... they were completely shocked!
But why does the price of a Big Mac go up over time?
To help explain this I got my girls to think of a world where there were 5 people each with $1 and the only thing they could buy was a Big Mac. McDonalds couldn’t charge more than $1 per Big Mac, as no one would have enough money to buy a Big Mac.
Now, suppose those same 5 people got an extra $1 each. Now McDonalds could charge more than $1 for a Big Mac as people had money to spend.
This is essentially what is happening in different countries but at a much larger scale. Governments around the world print new money. This new money ultimately ends up going to the people (granted, not to all people). As people have more money to spend, companies can, and do, increase their prices to match the increase in demand for spending and this is called ‘inflation’.
The chart below shows that the government wants inflation to be around 2% per year. Actual prices (for a big group of goods and services) has been between 0% and 3% per year over the last 5/6 years. [2022: Update - inflation went up to 10% per year]
Why has inflation spiked recently? [2022 update]
Inflation has spiked over 2022 and this is largely due to the conflict in the Ukraine.
The conflict means that the UK has less access to gas and oil. As there is only a limited supply, it means that people have to pay more for it.
This means companies like McDonald's has to pay more money to cook the burgers and fries (as they use electricity which comes from oil and gas). This means that McDonalds will make less money than before. To recover this cost, McDonalds could increase the cost of the Big Macs which leads to more inflation.
[I made it clear to my daughters that this is just an example, inflation is a basket of goods and services, not just Big Macs. Although, did you know there is a special Big Mac Index?]
Why should our kids care about inflation?
Inflation is such an important topic as it essentially erodes our ability to buy things in the future. As the first quiz showed, if you had $100 and kept it under the bed for 80 years, you’d go from being able to buy 62 Big Macs to only 7!
This might be an extreme example but it shows that if our money doesn’t grow then we won’t be able to buy as much 'stuff' in the future. Therefore, if you are keeping your money or your kids’ money in a long-term savings account, which doesn’t have an interest rate of over 2% per year, then you are getting worse off each year.
This is why investing in the stock market is so important. To show you why, here’s another quiz:
QUIZ: Imagine if you didn’t keep that $100 from 1981 under the bed but instead invested that money. How many Big Macs could you buy?
In 1981 (40 years ago)
In 2021 (today)
In 2061 (40 years into the future) *
* assuming a 7% per year return
Scroll down for answer ⬇️
That’s a lot of Big Macs. Especially compared to the amount if you kept that money under the bed (62, 20, 7 respectively)
Even with the price of a Big Mac going up from $1.60 to $13.30 over 80 years, You’d still be able to buy over 8,700 Big Macs as your money had been invested. This is because over the long-term money invested grows much faster than inflation.
Why does the stock market go up by more than inflation?
This is for those who like to get a bit technical.
Let’s imagine a Big Mac which sells for $4.95 (2021 price).
Some of that money is used to cover the cost of buying meat and potatoes from farmers to make the burger and fries. Also, some is used to pay for the restaurant and the people who work at McDonalds. Then there will be some left to give back to those who invested in McDonalds … the profit.
If the cost of meat and potatoes goes up, then McDonalds will increase the cost of their burgers to make sure they can still pay for the restaurant, people and a profit to investors. This might not happen straight away but eventually happens which means that over time, McDonalds (and its investors) will still be making money which grows at least in line with inflation.
On top of that McDonalds creates new burgers and opens new restaurants so it can sell more burgers. As they sell more burgers, they make more profit and this means the amount going to investors increases. This happens across most companies and hence why the stock market has gone up by more than inflation over the long-term.
Inflation is a very important money topic as our kids need to know that over time things are going to get more expensive.
If they are saving (which I really hope they are), then it’s important to make sure that money is growing at a faster rate than inflation. This is why I recommend parents help their kids invest their long-term savings. If you are new to investing, then please check out our 'How to teach kids about the stock market' blog and our Investing FAQ.
Thanks for reading!
P.S. This blog is no way an endorsement to buy McDonalds shares. It was for illustration purposes only. If you do invest, then I recommend investing in a wide range of different companies. Learn more about investing via my Investing FAQ. Your kids can learn more about investing by reading Grandpa's Fortune Fables.