Do you suffer from money illusion?

The greatest trick your money ever played was convincing you that its value would stay constant
Money illusion is no fairy tale
Money illusion is no fairy tale

If you think the first dollar the tooth fairy left beneath your pillow is still worth a dollar, we’ve got some bad news. First, the tooth fairy is magical, but she’s not THAT magical. And second, you may suffer from money illusion.

That gift was (probably) a real dollar, so the money itself wasn’t a mirage. The illusion comes in your thinking that a dollar back in the day is worth a dollar today. It’s a natural phenomenon; after all, the actual currency still says “one dollar.”

The thing is, we don’t naturally account for inflation, which these days runs about 2% a year. That means it’ll take $1.02 to buy as many groceries in 2021 as a dollar gets you today. Over time, that really adds up: Consider that a 1986 dollar could buy as much as two 2020 dollars. And that also means that if you didn’t get a 2% raise last year, your salary actually went down. 

Knowing about money illusion means you’re no longer fooled by it.

What’s to be done about this? First, know that it exists and know that unless you’re actively growing your money, it’s shrinking. And second, when it’s time to tell your kid about the magic of the tooth fairy, take the opportunity to tell them about money illusion as well.

Recommended Reading

Asset from Compound interest, defined 1

Compound interest, defined

It’s how your savings can grow exponentially, and it’s how the rich stay rich.

Exponential doubling is like folding paper.

Fold a piece of paper 8 times to understand investing

Hint: It’s all about exponential doubling

  • reality check
  • investing
  • origami