People often use the terms “cost of living” and “inflation” interchangeably, but the truth is that they are actually different things.
According to Investopedia, “cost of living” is more focused picture than “inflation”.
“This number averages the cost of an accepted standard of living that includes food, housing, transportation, taxes and healthcare. Cost of living is frequently used to compare life in different locations around the country or the world. For example, if you made $50,000 per year living in New York City, you could maintain the same standard of living in Chapel Hill, NC on half that annual salary – the cost of living in New York City is twice as high as in Chapel Hill.”
On the other hand, “inflation” is a look at the bigger picture and is really only a comparison of how much the currency is worth in terms of goods and services today vs. the past.
Investopedia reports that the inflation rate is often measured by the Consumer Price Index (CPI) – a monthly measure by the Bureau of Labor Statistics that averages the cost of a representative basket of goods and services from areas around the country. It then reports the result as a percentage rise or fall.
When you are thinking about the cost of living affects your personal finances, you are really thinking about inflation most of the time. For example, groceries are quite a bit more expensive than they used to be. This is an example of inflation in your everyday expenses.
Unfortunately, pay levels usually lag behind inflation by several years, which can be exceedingly difficult to deal with during times of rapid inflation. The cost of goods and services go up (because the value of the dollar has gone down) and yet you aren’t earning any extra money to cover that different in price.
Inflation is also an important factor to consider when saving and planning for retirement. Most retirement advisors will help you consider this factor, but you can also use an inflation calculator to see how inflation has changed over time and to estimate inflation changes in the future.
In general, the inflation rate is usually around 2-3% per year during a normal, stable economy. Recently inflation has been quite high. In the past the inflation rate has also been higher and at times it has also been lower. But this will give you at least an idea of what your money will be worth as you approach retirement in the future.
Inflation and a changing cost of living are a part of life. There’s no use trying to fight them or change them. But you can prepare for them by using planning ahead and using calculators to ensure that you have enough money set aside of your future needs.