Are Your Dollars Dragging?

You wouldn't trade a dollar bill for 86 cents (unless, perhaps, a close relative was asking). But that's what you're doing if you fail to calculate the effects of inflation on your lifetime savings.

As prices rise (and they tend to do so over the course of time), you want to make sure your income has the same purchasing power. Failure to incorporate inflation in your retirement savings calculations could leave you shortchanged in your later years.

Depending on whom you ask, what measure you use, and what time frame you look at, inflation over the past century or so has been 3% to 5%. Even though inflation has been pretty low for several years, take a trip down memory lane when double-digit inflation in the '70s and '80s put a damper on your dollars.

Now you are older and wiser -- and inflation can play an even larger role in your retirement plan. The rise in medical costs, for example, has far outpaced the overall rate of inflation. So it's probably wise to use at least a 4% inflation assumption as you do your retirement calculations.

As you do the math (tinker with this calculator), don't let your savings resolve droop. Steeling your savings for the inflation hit isn't complicated. The longer you'll be retired, the more you'll have to invest in securities that outpace inflation -- in other words, stocks. 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 and are exempt from state and local taxes.

Dividend-paying investments, such as the ones Fool analyst Mathew Emmert researches for his Income Investor Newsletter (take a free trial here), can help defy the effects of gravity and fortify your retirement portfolio. And if you're nearing the time when you will start dipping into your retirement savings, Robert Brokamp will show you how to Rule Your Retirement. Again, check out a free issue and pick up a few tips on making your money work hard enough to keep up with the times.

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