Inflation in Real Life

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« This Just Proves When It’s Your Time to go… | Main | Blog of the Week - No. 60 »

By JLP | November 18, 2006

Not too long ago, I was talking with my neighbor. He is in the process of trying to sell his house as he has decided to move to a retirement home. During the course of our conversation we started talking about careers. He was an engineer in the chemicals business. I told him that chemical companies are paying chemical engineers fresh out of college over $86,000 per year. He nearly fell over when he heard that. Then he told me that when he retired in 1985, he was making $52,000 per year.

Sure, $52,000 per year doesn’t sound like much when comparing it to $86,000. However, we have to keep in mind that he was making $52,000 per year 21 years ago. What would a salary like that be equivalent to today? Take a look at the graphic below:

What this shows us is that had this guy been able to keep working through the years and recieved cost-of-living raises each year, he would have been making nearly $97,000 in 2006. Since he was in the engineering field, which seems to be a hot field lately, it is likely that he could have seen salary increases of 5% per year over the last 21 years, which would have him making over $144,000 in 2006.

What does this tell us? Inflation is sneaky! That 3% - 3.5% per year really adds up over the years. Here’s a look at what someone making $86,000 per year now could be making in 21 years:

Pretty amazing isn’t it? Unfortunately, the prices of goods and services will be rising right along with those salary increases.

THE MATH…

If you are interested in the math, you can calculate these numbers on your own if you use the following formula:

Salary in the Future = Today’s Salary × (1 + Inflation Rate)^{Number of Years}

So, a person making $86,000 per year now, who expects their salary to rise 3% per year for 21 years, can insert this information into the formula to get the following equation:

Salary in 21 years = $86,000 × (1 + .03)²¹

Salary in 21 years = $86,000 × 1.86029

Salary in 21 years = $159,985

See how easy that was?

Now…

If you want to go back in time and see what a salary today would have been 21 years ago, you can use this formula:

Salary 21 years ago = Today’s Salary ÷ (1 + Inflation Rate)^{Number of Years}

Using the same numbers as above:

Salary 21 years ago = $159,985 ÷ (1 + .03)²¹

Salary 21 years ago = $159,985 ÷ 1.86029

Salary 21 years ago = $86,000

Topics: Financial Math Basics |

Comments to “Inflation in Real Life”

Gem Hudson Says:
November 18th, 2006 at 8:14 am

But when the wealth building is no longer there anymore, there is nothing to pay what ever they were worth.

Jim Says:
November 18th, 2006 at 8:43 am

The formula is ‘fun’ or ‘painful’ but somewhat unrealistic. In reality when the employment market (high unemployment) and the economy are flat, pay levels also stay relatively flat. This was true for a period of 8-10 years in the mid 90’s and beyond before the current low unemployment economy. In those years employees received no increases or increases averaging 2%. This formula therefore sets unrealistic expectations. Certainly there are always job skills that are in high demand and low supply and operate in a real supply-demand scenario, commanding above-average pay levels. A chemical engineer is likely a good example.

Rich Slick Says:
November 18th, 2006 at 9:45 am

This is also deceiving because it doesn’t factor some other costs such as:

1. Astronomical increases in health care costs which have been averaging 7% over the past few years. CPI doesn’t factor these in.

2. Increases in Payroll/Social Security thresholds and taxes

3. Realistically, there is a salary cap on some positions and I’ve seen some people get little or no raise because they are already at or above the going market rate for a particular job description.

4. Lastly, I’m make an argument that the days of a standard 3% increase for cost of living adjustment are coming to an end. Globalization and outsourcing to places like China & India will make it progressively difficult to justify paying higher wages when employers can cut their labor costs in half by simply moving the job offshore.

JLP Says:
November 18th, 2006 at 12:44 pm

Rich,

I have to disagree. There is nothing decieving about this post. I’m not saying that ALL jobs will grow at these rates, I’m just running “what if…” scenarios.

efipo.com Says:
November 18th, 2006 at 1:37 pm

JLP posted the salaries prior to any deductions whether its from SS or Medicare. I mean you could also argue that he didn’t post anything about the inflation in products, but that is assumed just like the other “COLA’s” of life. If you’re referring to a point in time where there’s inflation with no kind of job increase you’re referring to stagflation. There really hasn’t been any kind of inflation since the early 80’s.

Yes there are salary caps, but they have to adjust with inflation. The scenario that he pointed out is very accurate especially in TX.

Foobarista Says:
November 18th, 2006 at 4:24 pm

One thing that’s clearly true is that even with inflation, ChemE’s are making more than the “old days”. After all, he was presumably a highly experienced, senior engineer when he retired. The starting salary is for a 24 - or at worst a 28 - year old (assuming it’s for someone with an MS or PhD in ChemE). So, even with inflation, salaries have gone up in that field.

Jake Says:
November 18th, 2006 at 5:06 pm

I’m curious where the original $86,000 for a chemical engineer fresh out of college came from?
I’m a recent chemical engineering graduate and in my experience a starting salary around $55,000 was the mostly the rule. I went to work in the oil industry and only got a starting salary in the low 60s, and the oil industry tradtionally pays the highest salaries for ChemE’s.

According to the CNN/Money article here: http://money.cnn.com/2006/04/07/news/economy/jobs_collegegrads/index.htm
The average starting salary for a ChemE in 2006 was $56,549.

So not trying to take away from your point about inflation, but I’m curious where the $86,000 figure came from. Perhaps I should be looking to take a job somewhere else if I can increase my (already high) salary 40%.

JLP Says:
November 18th, 2006 at 5:16 pm

I got that number from my wife who is employed in the industry and also is partly responsible for interviewing/choosing candidates.

Nationwidebillrelief.com Says:
November 18th, 2006 at 7:43 pm

Gas was less than 0.99 cents per gallon, now it is around $3.00. You could by a brand new car for around $7,000 dollars that now cost $18,000. The point is he made very good money in 1985 and was considered to be in the upper middle class. He probably did not have to deal with as much stress as today and he did not have to complete the same amount of education requirements an engineer requires now.

» Blog Links of the Week on Blueprint for Financial Prosperity Says:
November 18th, 2006 at 8:56 pm

[...] Inflation sucks. (well, on an individual level, it’s good on a macro level) [...]

Daly Says:
November 18th, 2006 at 9:13 pm

Boy, if we weren’t doing what if’s scenarios, I would really hate to see a realistic formula. If I were to make one up, it might go something like this:

Salary in the Future = [Today’s Salary × (1 + Inflation Rate)^Number of Years]/[(Age^number of years)

Daly Says:
November 18th, 2006 at 9:15 pm

Hey, html omitted the rest of my formula. I gotta make sure to share it! Let’s try again.

Salary in the Future = [Today’s Salary × (1 + Inflation Rate)^Number of Years]/[(Age^number of years)

Daly Says:
November 18th, 2006 at 9:19 pm

SIGH…I give up. This is why the formulas should be left to JLP. Sorry, JLP!! (My formulas was pretty accurate because it factored in two kids and the cat’s cut).

T.S. Says:
November 18th, 2006 at 10:11 pm

You should check out Tom’s Inflation Calculator:
http://www.halfhill.com/inflation.html

The calculator allows you to see the affect of retail price inflation or wage inflation on amounts.

A $52k salary in 1985 equals about $96k based on wage inflation in that time period or almost $98k based on retail price inflation.

If you take the $86k Chemical Engineer salary back to 1985 based on wage or reatil price inflation it would have been about $46k.

Try out the calculator and see how much your salary would have been in the past based on the documented wage and retail price inflation.

This gives a really good picture of what your neighbor would be making. $144k based on a 5% annual increase is not realistic, just look at the rates for engineers on Salary.com and you will see that wages in general track against the market and inflation. What could have happened, is your neighbor moved into management into a different pay structure if he kept working.

In general, pay for jobs move upward pretty much with inflation over the long term. Short term demand could make one position get better pay initially, but this will eventually even out.

Nigel Says:
November 19th, 2006 at 1:11 pm

Rich (post #3):
Your argument about globalization’s effect doesn’t tell the whole story. One could argue equally well that the cost savings due to outsourcing will allow companies to reduce prices, leading to lower inflation in the US.

In reality, the effect of outsourcing may not be as much as people think. I cannot speak for China, but in India the local salaries and living expenses are increasing so fast that it will eventually make the cost savings due to outsourcing to India much less attractive.

Rich Slick Says:
November 19th, 2006 at 10:23 pm

Nigel,

The total population of the US is 300 million. India has 1 billion and China has 1.3 billion. The numbers are just staggering and I simply don’t see how it’ll “even” out without some sort of detrimental affect to US worker but only time will tell. Worse yet, we have 80 million people retiring from work here over the next 20 years so you really have to wonder who’s going to be stepping up to the plate to lead the world in the next few decades.

Fortunately, I’ll be visiting China sometime next year and I’ll take a first hand look at what’s really happening there. It seems just about everyone I know is planning on a trip to China for business reasons sometime next year.

Matt Says:
November 20th, 2006 at 2:28 pm

The power of inflation is the same power of compound interest. The growth over time becomes huge even if the individual growth per year is small and because the yearly growth is so small people forget to take it into account properly.

Good Post.

Miguel Says:
November 21st, 2006 at 6:57 pm

Rich, given all the figures on how horribly unprepared for retirement most folks in the U.S. are, I seriously doubt the projected retirement rates you read about all the time. A large bulk of that figure will be delaying retirement, both out of necessity, as well as out of preference. Traditional retirement is headed towards extinction, as it probably should anyhow.

Flexo Says:
November 22nd, 2006 at 2:59 am

Perhaps they can delay retirement, but they can’t delay death. Eventually, the large number of baby boomer-workers will disappear — whether due to retirement or death doesn’t really matter on the grand scale (but of course it matters on the individual level). Sorry to be so morbid.

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Inflation in Real Life