FEATURE — Failing to include inflation in your retirement planning can create unnecessary hardship in the future.
Most investors only consider the risk to their principal, which is why many prefer certificates of deposit over non-Federal Deposit Insurance Corp. insured investments for their most protected assets.
The risk of lost buying power is a more complicated dynamic. The dollar value of the principal stays the same, but a dollar buys less and less year after year. This happens so gradually over time. A gallon of milk increases a few cents over months. It is easy to tune out the constant, low-level increases in utility fees like electricity, shipping of goods and services, gasoline, heating fuel and water delivery.
Inflation is insidious this way, and it varies so widely over the range of goods and services that it’s hard to gauge the actual effect on an individual basis. For example, individuals paying for their major medical coverage who are experiencing any health care issue noticed double-digit spikes in the year-to-year increases in health insurance and medical care.
If health care costs become a significant percentage of purchases in any given year, the massive erosion of health care buying power can affect the risk of loss from inflation. Individuals who are young, healthy or receiving high-quality coverage from their employers may not see health care inflation affecting their buying power nearly as much.
Noticed or not, inflation is real, and it can vary widely based on an individual’s circumstances. To offset inflation, your income must rise each year. Assuming you do not go back to work, this income must come from a pool of assets that is also growing.
Inflation is dangerous, the most perilous roadblock in retirement planning. Inflation is the retirement planner’s largest and most focusing problem. Inflation must be calculated into any responsible plan.
“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman,” Ronald Reagan once said.
In simple terms, inflation can be defined as either a rise in prices or a fall in money value. The short answer is: “An increase in the cost of things that are necessary for humans to live and enjoy life, such as bread, butter, milk, cheese, coffee, oil, shelter, clothing, medical services, chicken, cotton, and electronics.” Or “a decrease in the value of money so that it takes more dollars to buy the same goods and services it did in the past.”
Looking back just a few years will show examples of how inflation can drastically affect fixed retirement income. Since the 1950s inflation has increased average prices 1,000% or more as of November 2020.
For example:
- A postage stamp in the 1950s costs 3 cents; today’s cost is 55 cents – 1,800% inflation.
- A gallon of full-service gasoline cost 18 cents before; today, it is $3.45 for self-service – 1,567 % inflation.
- A new house in 1959 averaged $14,900; today’s average home costs $282,300 – 1,795% inflation.
- A dental crown used to cost $40; today it costs $940 – 1,950% inflation.
- An ice cream cone in 1950 cost 5 cents; today, you’ll spend $3.50 – 5,900% inflation.
- Several generations ago, a person worked 1.4 months per year to pay your federal tax bill; now, it takes 5 months.
In the past, the one wage-earner families lived well and built savings with minimal debt, and many families paid off their home and college educations for their children without loans. How about today?
A few years ago, few citizens know that the government changed how they measure and report inflation as if that would stop it. Families know better when they pay their bills for food, medical costs, energy, property taxes, insurance and try to buy a house.
Inflation is part of our lives, and it must be part of retirement planning.
Considering the future date that you plan to retire can help you build an inflation factor into your planning. The U.S. Department of Labor Bureau of Labor Statistics maintains an inflation calculator that you can find here.
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