The Money Illusion

My grandfather kept a little spiral notebook in the glove box of every car he ever owned. Every time he filled up, he wrote down the date, the gallons, and the price. He did this for something like 50 years.

When he passed, my mom found a shoebox full of those notebooks. I spent an afternoon flipping through them. Gas at 31 cents. Gas at 89 cents. Gas at a dollar and change, with a note in the margin that just said "robbery."

What struck me wasn't the prices. It was that every single time the number went up, he wrote it down like it was news. Like it was a betrayal. Fifty years of being surprised by the same thing.

He wasn't a foolish man. He ran a hardware business for decades and never missed a payroll. But he thought in dollars, and the dollar kept moving underneath him.

That's what I want to talk about this morning.

Economists have a name for it. Irving Fisher called it the money illusion almost a hundred years ago: our tendency to think about money in nominal terms, the number on the price tag or the paycheck, instead of real terms, what that number can actually buy.

It sounds like an academic quirk. It's not. It's probably the most expensive cognitive error ordinary people make, and it's invisible precisely because the unit we use to measure wealth is the thing that's changing.

Imagine measuring your kid's height every birthday with a tape measure that quietly shrinks a few percent a year. The numbers would go up. You'd feel great. You'd have no idea whether your kid was actually growing.

That's what the dollar is. A tape measure that shrinks. Most years it shrinks slowly enough that we don't notice. Some years, like this one, it shrinks fast enough that people start writing "robbery" in the margins.

Consumer prices are up 3.7 percent from a year ago. Gas is up a third. And this month, the Social Security Administration told 70-some million people that their checks will rise 3.6 percent in January. That's a raise in the paperwork and a small pay cut in real life. Second year in a row.

Almost nobody will feel it as a cut. That's the illusion working exactly as designed.

Once you start looking for it, you see it everywhere.

The raise. Someone gets a 3 percent raise this year and feels like they moved forward. With inflation running near 4, they moved backward. They'll spend accordingly, as if they're richer, and wonder why the budget feels tighter by spring.

The house. People say their house "doubled" over 20 years. Prices overall rose by something like 65 or 70 percent over a similar stretch. Subtract property taxes, insurance, maintenance, and a new roof, and a lot of houses that doubled made their owners a modest real return. Still a fine place to live. Just not the wealth engine the number suggests.

The savings account. A 4 percent yield felt like a gift in 2024. The same 4 percent today, with inflation at 3.7, is basically treading water, and after taxes it's sinking slowly. The number didn't change. The meaning did.

The portfolio high. Every market that's been through serious inflation has a version of this. Nominal prices hit records while real wealth goes nowhere. There were long stretches in the late 1960s and 1970s where the stock market looked roughly flat on a chart but lost a huge chunk of its purchasing power. The people who owned it felt like they were waiting. They were actually losing.

The debt. Here's the one that flips. If you have a fixed-rate mortgage at 3 percent and inflation runs at 4, the real value of what you owe is shrinking every year. The illusion makes people rush to pay down cheap fixed debt, when the shrinking ruler is quietly paying part of it off for them.

In every case, the mistake is the same. Someone looked at the number and forgot to ask what the number was made of.

I don't think this is a knowledge problem. Ask almost anyone whether inflation matters and they'll say of course. Ask them to describe their own finances and they'll do it entirely in nominal dollars.

Part of it is that nominal numbers are what we see. Paychecks, statements, price tags, home values on an app. Real numbers require a calculation, and calculations take effort. The brain is lazy in exactly the way that costs money.

Part of it is emotional. A rising number feels like progress, and we want to feel like we're making progress. Real returns are often smaller and slower than nominal ones. Measuring honestly can feel like voluntarily taking away a little good news.

Part of it is anchoring. Most of us carry around a mental price list from some point in our twenties. A movie costs this. A sandwich costs that. A decent car costs this much. When reality drifts away from that list, we don't update the list. We get irritated at reality. I still catch myself flinching at a 7-dollar coffee like it's a personal insult, even though I know exactly why it costs that. The anchor doesn't care what you know. It just sits there, quietly telling you that the old number was the real one and the new number is a mistake.

And part of it, I think, is that the dollar is the water we swim in. We earn in it, spend in it, save in it, dream in it. It's very hard to step outside your own measuring stick and ask whether the stick is reliable.

I spent a decade on trading desks where every single return was reported in real terms, net of fees, net of inflation, risk adjusted. And I'll be honest. Even there, people would get excited about nominal records. The illusion doesn't care how smart you are. It cares whether you've built a habit that corrects for it.

So if dollars are a slippery ruler, what's the right one?

I've landed on a pretty simple answer. Real wealth is the ability to keep living the life you want, for as long as you want, without having to trade your time for it.

That's it. Not a number. A capacity.

When you measure it that way, a few things become obvious.

Productive things beat static things. A business that can raise prices when its costs go up. A rental whose rent resets every year. Shares in companies that sell things people keep buying. Your own skills, which get paid more as the world gets more expensive. These things tend to carry their value through a shrinking-dollar year, because they produce something people need and can reprice it. A pile of cash can't reprice anything.

Protection has a real definition. Safety isn't a balance that doesn't go down. It's purchasing power that doesn't go down. That's a very different thing, and it's why I care so much about having a slice of money that's tied directly to inflation instead of just sitting in an account that feels safe.

Time is the one asset the illusion can't touch. Every year a dollar buys a little less. An hour never buys any less of your life. That's why the people I most admire financially seem almost stingy about their time and relaxed about small sums of money. They figured out which ruler doesn't shrink.

Ownership compounds in real terms. A dollar put to work at 16 has nearly 50 years to outrun inflation. A dollar put into a machine that makes your business more productive keeps earning in whatever dollars the future uses. The earlier and more directly you own productive things, the less the ruler matters.

Back to my grandfather's notebooks.

The thing I keep coming back to is the surprise. Fifty years of rising prices, and every single increase felt like news to him. I don't think that cost him much at the pump. But I wonder what it cost him in other decisions.

Did he keep too much in the bank because it felt safe, when it was quietly losing a few percent a year? Did he hold off on expanding the store because the price of a new building looked shocking compared to what he paid for the old one, not compared to what everything else now cost? Did he feel poorer in his 70s than he actually was, or richer?

I'll never know. But I recognize the pattern, because I've seen it in myself.

There was a stretch, early in my career, when I sat on a big pile of cash for almost two years waiting for a "better time" to invest it. I watched the balance like a hawk. It never went down. I felt prudent. Then I did the math one day, in real terms, and realized I'd quietly given up something like 8 percent of my purchasing power by keeping it so safe. The balance never went down. The money did.

That's the money illusion in one sentence. The number stayed put and I got poorer.

You don't need to become an economist to fix this. You need a couple of habits that force the right unit back into the conversation.

Ask "real or nominal?" out loud. Whenever someone tells you a return, a raise, a price, or a home value, ask what it is after inflation. You'll be surprised how often the person telling you hasn't thought about it either.

Name your own inflation number. The official rate is an average across everyone. Your number depends on what you actually buy. If you drive a lot and heat with oil this winter, your personal number is a lot higher than 3.7. Know it, roughly, and measure your progress against it.

Measure the big stuff in years, not dollars. How many years of your current spending could your savings cover? Did that number go up or down this year? It's an imperfect metric, but it's in real terms by default, because your spending already reflects current prices.

Respect what can reprice. When you're choosing where money goes, give extra credit to things that can raise their price when the world does. Skills, businesses, productive assets, and anything tied directly to inflation.

Be suspicious of feeling rich. If you feel richer than last year, check. Sometimes you are. Sometimes the ruler just got shorter.

Almost every good money move I know comes back to this one idea. Most of them aren't really tricks for beating inflation. They're ways of measuring money in the unit that actually matters.

A guaranteed real return. A dollar given decades to grow. A business that buys tools that make more than they cost. Each one is a way of owning something the shrinking ruler can't easily get to.

The illusion is comfortable. It tells you the number went up, so you're doing fine. Real wealth asks a harder question, and it asks it every year: can I still buy the life I want, for as long as I want it?

That's the only number I really care about now. It's the one my grandfather was trying to track in that glove box, a gallon at a time, without quite knowing it.

Take a few minutes today and ask it about your own money. Not in dollars. In years. In freedom. In the stuff that doesn't shrink.

See you Monday.

Alex Rivera, Wealth Architect at Wealth Grid