January 25, 2005
Inflation does to one's lifetime savings what gravity does to one's hindquarters: Both have an undeniable drag on the bottom line. Or, more to the point: As prices rise, income doesn't purchase as much.
How big of a drag will inflation be when you retire? Depending on whom you ask, what measure you use, and what time frame you consider, inflation over the past century or so has been 3% to 5% annually. Even though inflation has been pretty tame for several years, you probably remember the double-digit whammo during the '70s and '80s. Plus, the rise in medical costs -- a huge concern for retirees -- has far outpaced the overall rate of inflation. So it's probably wise to use at least a 4% inflation assumption as you make your retirement calculations.
As you do the math (tinker with this calculator), don't let your savings resolve droop. Steeling for the inflation hit isn't complicated. The longer you'll be retired, the more you'll need to invest in securities that outpace inflation -- in other words, stocks. (Here's a brief overview of retirement planning.)
You also have another option: government securities that are guaranteed to keep pace with inflation, namely, TIPS and I Bonds. These are great investments because, besides the protection against inflation, TIPS and I Bonds are backed by the U.S. government, are exempt from state and local taxes, and can be bought commission-free from Treasury Direct. (Here's more reading on inflation-protected investments.)
Dividend-paying investments, like the ones recommended by Income Investor analyst Mathew Emmert (sign up for a free trial and a free copy of Fool analyst stock picks), can help defy the effects of gravity and fortify your retirement portfolio.
Now, saving for the gravity-defying buttocks lift is another matter.