Image source: Getty Images
A key mistake that many people make when planning, saving, and investing for their retirements is ignoring inflation. That's dangerous, because inflation tends to shrink the buying power of your money over time, and if your retirement is 20 or 30 years away, it can do a lot of damage.
Don't let inflation whack your retirement. Image source: Getty Images
For example, if you're earning $75,000 per year now, and think you can get by on $40,000 plus $20,000 of Social Security income in retirement, you might figure that you need to save a million dollars. With a million, if you use the 4% rule (which is both helpful and problematic), you'll withdraw $40,000 in your first year of retirement and then adjust subsequent withdrawals for inflation. That might sound good, but if your retirement is 20 years away and you arrive at it with a million dollars, if inflation has averaged 3% annually over those years (as it has, historically, over long periods), that million dollars may only be worth $540,000 or so in today's dollars. Applying the 4% rule to that will only start you off with roughly the equivalent of $21,600 in your first retirement year.
To be clear, you'll still have $1 million and will still withdraw $40,000, but it will only have the buying power that about $21,600 has today, because most costs will have increased. Check out the table below to see how various common expenses may increase in value over the coming 20 or 30 years. They reflect 3% annual growth, which may turn out to be higher or lower than the average annual inflation growth rate during those periods.
|
Item |
Typical Cost Today |
Possible Cost in 20 Years |
Possible Cost in 30 Years |
|---|---|---|---|
|
Large fancy coffee |
$4 |
$7.24 |
$9.72 |
|
Hardcover book |
$30 |
$54.30 |
$72.90 |
|
Pack of cigarettes |
$6 |
$10.86 |
$14.58 |
|
Gallon of gas |
$2.20 |
$3.98 |
$5.34 |
|
Pet ownership, one year |
$1,500 |
$2,715 |
$3,640 |
|
Plane ticket |
$400 |
$724 |
$971 |
|
New car |
$30,000 |
$54,300 |
$72,900 |
|
Movie ticket |
$9 |
$16.29 |
$21.87 |
|
College, one year (for in-state, public colleges) |
$22,000 |
$39,820 |
$53,460 |
|
Utility bills, per year |
$2,000 |
$3,620 |
$4,860 |
|
Lawn care, per year |
$1,200 |
$2,172 |
$2,913 |
|
Meal at restaurant |
$25 |
$45.25 |
$60.75 |
Your particular costs may be quite different -- for example, if you have no pets or only buy used cars or never fly anywhere -- but the table should still give you an idea of how expenses will likely rise in value. It's always possible, too, that some costs might drop -- as the price of gas has in recent years. And many costs can rise faster than the rate of inflation -- as college tuitions and healthcare have being doing for a long time. (Here's the secret formula: If you want to see what something will cost if it grows in value by 3% annually over 20 years, multiply by 1.81. For 30 years, multiply by 2.43.)
Inflation will shrink your money's purchasing power. Plan for that. Image source: Pixabay.
What to do
As you plan and save for your retirement, have a realistic target in mind, a sum that will be able to provide you with your desired purchasing power when you retire. If that means that you're suddenly behind schedule, fret not. It will only make a big difference if you're many years away from retirement, so you should have ample time in which to save more aggressively. Simply working one or two more years and retiring a bit later than you'd like can also make a big difference. For instance, if you've amassed $600,000 for retirement and you can leave that sum to grow for two more years at an annual average growth rate of 8%, it will become roughly $700,000.
Here's another comfort: Social Security benefits are adjusted for inflation. So if you start out collecting $20,000 per year, you may well be collecting close to $27,000 annually a decade later. Spend some time learning more about Social Security strategies, though, to be sure and get as much as you can from that critically helpful program.
