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It's a terrible monster, one of the worst ever seen.
One U.S. president wanted it whipped.
His successor called it "dangerous" and demanded urgent action to defeat it.
It was finally driven away by a very tall man, who had to resort to drastic, unprecedented measures.
It has stayed quiet and docile for many years.
But now there are whispers and rumblings throughout the land, warning that this monster will soon rise again. And it could wreck your financial future if you're not prepared. Are you?
What the heck are you talking about?
I'm talking about inflation, the tendency of prices to go up -- or put another way, of money to lose value over time. A little bit of inflation -- 3% or so -- is normal in a capitalist economy, even healthy, say many economists. But many folks fail to account for it when planning for financial goals a decade or three in the future, and that's a failure that could prove very serious given our current economic situation.
Inflation isn't one of the problems our battered economy is serving up right now. But there's a real chance that some of the drastic measures being taken by the world's central banks -- throwing a lot of new money into the global economy -- could lead to serious, double-digit inflation a few years down the road.
But even if it doesn't, inflation is something you need to be thinking about.
Let the tall guy kill it again. Why should I care?
Because your money needs to grow faster than the rate of inflation to really grow, and it will need to grow that much more if the inflation rate takes a leap -- even if "Tall Paul" Volcker and others in the administration manage to bring it under control after a year or two, it'll still take a big bite out of the buying power of your savings. Those Treasury bonds might not be as safe as you think.
Wait. Treasuries are as safe as it gets. Right?
Yes and no. If you bailed out of the stock market and bought Treasuries last fall or winter, you're probably earning less than 4%, maybe a lot less. That isn't going to cut it over the long term. Even if you bought TIPS -- "Treasury Inflation Protected Securities," with an interest rate that adjusts for inflation -- the premium over the inflation rate isn't going to give you much if any growth. Not enough to retire on.
TIPS will preserve your capital, but if you need growth to achieve your long-term goals, you need to get back into the stock market. If you're still in stocks, you need to be smart about what you own.
Uh-huh. The S&P 500 is lower now than it was 10 years ago. How does that help me?
The S&P 500 is not every stock in the stock market. It's an index of big U.S. stocks, and the biggest -- names like, oh, Microsoft (Nasdaq: MSFT ) and General Electric (NYSE: GE ) , just to pick a few -- have much more impact on the index's movements than smaller companies such as Wynn Resorts (Nasdaq: WYNN ) and Pulte Homes (NYSE: PHM ) .
Many of those big-name stocks have gotten torched recently, but lots of folks have made good returns in the last decade with stocks, whether chosen on their own or via mutual funds. Not just crazy flyers like Dendreon (Nasdaq: DNDN ) , either -- boring old Altria (NYSE: MO ) has more than tripled over that time, if you count reinvested dividends and the value of the Philip Morris International (NYSE: PM ) spinoff. You can find lots and lots of other examples. But you didn't need to own individual stocks, or even world-beating mutual funds -- even index funds have worked out for those who owned a diversified set of them.
The Fool's retirement newsletter, Rule Your Retirement, maintains a set of "model portfolios," asset allocation guides for retirement investors. Their long-term model -- which is all in stock mutual funds, by the way, and is designed to be easy to implement with almost any 401(k) plan -- has returned 26% over the last 10 years. That's almost enough to have stayed ahead of inflation even during the one of the worst periods for stocks in history -- and not bad for something that just about anybody can do with half an hour of effort a few times a year. And with a little more effort, you can do a lot better.
Long story short
Here's what I hope you'll take away from this: It's not enough to just "save for retirement." If (for instance) the average price of a new car is $60,000 when you retire instead of $20,000, and if you'll need $3 to buy what $1 buys now, just "saving" might not give you enough money to do what you want to do.
As Foolish retirement guru Robert Brokamp said in the latest issue of our Rule Your Retirement newsletter, "having just two figures in mind -- the current value of your portfolio and your retirement date -- isn't the best way to think about your nest egg." The "best way" Robert describes includes taking inflation into account, as well as a couple of other small but important shifts in mind-set that can help you build a much better retirement without adding a lot of work along the way.
If you'd like to read his article -- I heartily recommend it -- help yourself to a 30-day free trial of Rule Your Retirement. The trial gives you full access, so while you're in there, check out those model portfolios I mentioned -- you might find that a better investment strategy is easier to implement than you think. Just click here to get started.