Building wealth means earning returns that exceed inflation. That is why leaving money under your mattress or in a bank account may prevent you from achieving your goals. In the past 20 years, Australia’s inflation rate has mainly stayed between 1.5-4.5 per cent per annum, with the majority of the years falling between 2-3 per cent. It currently sits at 3.6% for the year up to March 2024.

This figure is an average, guided by CPI and based on an ordinary household. Your personal inflation rate takes into consideration your individual circumstances and where you spend your money. This indicator gives you a better understanding of the rate your money needs to grow at to ensure your purchasing power is growing in real terms.

Since we all spend our money on different products and services in different regions, it’s useful to think in terms of personal inflation. The inflation rate above doesn’t always apply to each individual’s circumstances. CPI is calculated on an ‘ordinary household’ in Australia, with the below allocations used in 2023-2024.

ABS CPI 2023-2024

A personal inflation rate is benchmark for maintaining purchasing power. The good news is that understanding your personal inflation rate gives you guidance about your investment strategy.

Your personal inflation rate has many uses, and should be used as inputs into your goal and financial planning including:

1. Your interest rate on cash

If your personal inflation rate is higher than the interest rate that you are receiving in your bank account, your purchasing power is decreasing. This means that your cash is decreasing in value and you won’t be able to purchase the same amount of goods and services in the future that you can today.

There are many legitimate reasons why cash may be kept in bank accounts, such as for an emergency fund or part of a retirement strategy. If you are holding cash unnecessarily and you are not able to find a higher interest rate, you are not maintaining the purchasing power of your money. We advocate for investors to focus on risk capacity instead of risk tolerance when deciding on asset allocation. This helps to reduce holding a high proportion of defensive assets unnecessarily.

2. Your investment projections and portfolio planning

Inflation is a key input into your portfolio construction process. It informs the purchasing power of your future portfolio and the rate of return you require to reach your financial goals. Using a generic inflation rate means that you may be under or overestimating the amount you need to achieve your goal. For example, my personal inflation rate is at 4.65%. This is mainly due to my spending in housing, alcohol and food – all which have higher inflation rates than the headline 3.6%.

I ran a scenario in Morningstar’s Portfolio Projection tool. If I had $100,000 and contributed $1,000 monthly over 20 years, earning a return of 6% p.a, these would be my results.

inflation rate future results

3. Your withdrawal rates in retirement

Inflation will impact how much you spend in your retirement. Even if your spending habits do not change year to year, inflation will make your cost-of-living rise. This needs to be accounted for in retirement planning. You can read more about how to account for inflation in withdrawal rates here.

What's your personal inflation rate?

You can calculate your own personal inflation rate (March 2024 figures) using our spreadsheet and by following the steps below.

1. Click here to download the spreadsheet and save a copy on your computer.

2. In the “Amount spent over the year” column input the amounts that you spent on each category. If you’re not sure how much you spent over the year, the Moneysmart Budget Planner is an excellent tool. It is comprehensive and accounts for one off expenditure that may occur annually (e.g. rates, car rego) that a quarterly budget may not catch. This means it is more representative of your spending.

3. The spreadsheet will automatically calculate your personal rate of inflation for each category (Column G) and your overall personal rate inflation (Cell G20).

Review

CPI and inflation numbers are released every quarter. This does not mean that you must review your personal inflation rate every quarter and change the trajectory of your investment plan. As part of your portfolio review, whether that is semi-annual or annual, review your personal inflation rate. This will matter more for investors that are making withdrawals in retirement, or for cash holdings that are spent.

It is important to be wary of once off expenses – you may not be going on a $20,000 European holiday every year. It is unlikely you are purchasing a $30,000 car every year. This will impact your personal inflation rate and it may be worth omitting these expenses for future planning.

For investors who are using it as an input to calculate long-term goals, again, it is worth considering the drivers of a drastic change in your personal inflation rate. Whether it is one-off expenses or abnormal economic environments that will not continue over a longer time period. Over time, inflation tends to smooth out and fall within a 2-3% band in Australia. It is likely that your personal inflation rate will have a similar band that you are able to use as guidance. It is not likely that you will have large jumps or falls often but be informed about whether it is worth changing the goalposts.