Should You Be Worried About Inflation?

My wife and I recently started watching the series Mad Men on Netflix.  I know, we are behind the times but it is just one of those shows that we never got around to watching until now.  Among the many startling things about the show (I can’t mention it here, but for those of you who have watched the series, you know what I mean), one thing that stood out to me was how little things seemed to cost in those days.   

In 1960, Don Draper, is an advertising executive making around $45,000 per year.  He lived in a huge house that cost about $30,000.  He purchased a Cadillac for about $6,000.  This might not seem like a lot of money today, but when you compare it with the 1960 cost of living chart on the left, he was definitely wealthy and living a lavish lifestyle.  It is hard to imagine though that the average salary was $5,1999 per year, rent was only $98 per month and you could go to the movies for $1!

Fast forward to today, Don Draper’s salary would be $303,854[1] his Cadillac would cost $52,000, and his home would be valued in the low millions.  Income and cost of living in the United States have increased tremendously since 1960.

We know that prices go up each year but why?  Over time prices rise due to increased demand for goods and services.  This increase in price is known as inflation.  The percentage increase or decrease in prices over a period of time is called the inflation rate.  As inflation increases the purchasing power of the dollar declines as more money is required to purchase the same goods or services.  Over the last 20 years, our population and economy has grown tremendously.  Naturally, prices, income, and inflation has grown as well.  Today’s prices are 768.16% higher than they were in 1960.   That means it takes $8.68 to buy what $1 did back in 1960[2].  

While the effects of inflation can be clearly seen over a long period of time, the impact on an annual basis can feel small or even insignificant.  Surprisingly, for most of the last 60 years, with the exception of the late 1970’s and early 1980’s, inflation has hovered around 2% to 3% annually.  According to the Beurau of Labor Statistics, over the last 5 years, the annual rate of inflation has been closer to 2%.  To keep pace with inflation, salaries tend to rise at a similar pace, called a “cost of living” increase.  This helps to soften the impact of rising prices.

But with inflation being so low over the last few years, should you still be concerned that it will erode your spending power in retirement?  The answer is yes!  As the last 60 years has shown, inflation might not be noticeable on a daily basis, but over the long-term, inflation has a clear impact on your life and your ability to live comfortably in retirement.  Here are four things you can do to shield you from the impact of inflation.

1.  Stay Invested

Over time inflation does erode the purchasing power of the dollar.  Therefore, your retirement savings before and after retirement, should be invested at a higher rate of inflation so that your money retains its purchasing power in retirement.  This means investing your money in a diversified portfolio of cash, bonds, and stocks.  While investing in the stock market does involve the risk of loss, there is also risks of not investing as well.  Keeping your money in cash means you run the risk of not having enough money to fund your retirement due to inflation.  

2.  Know What Your Retirement Spending Will Be

You should also have a clear idea of what your expected annual retirement expenses will be so you can calculate what the inflation adjusted amount will be when you retire. That way you will have a better idea of how much you will need to save in order to meet your retirement spending needs.  For example, You may wish to retire in 15 years, you believe your basic living expenses to be $50,000 per year today and you expect to live 30 years.   Naturally you would think you would need to accumulate $1.5 million in savings.  However, this does not take inflation into account.   At a 3% rate of inflation, your living expenses in your first year of retirement would actually be closer to $78,000.  You will need to save much more than $1.5 million and / or at a higher rate of investment return to keep up with inflation in retirement.  Having a clear sense of your basic retirement living expenses and the inflation rate will help you better estimate how much you will need to save.

3.  Consider Your Cost of Living In Retirement 

The less expensive your lifestyle in retirement, the better you will be able to absorb the impact of inflation.  If you live in the San Francisco Bay Area, you already know that the cost of living here is one of the highest in the United States.  Therefore, you will need to save considerably more to fund your retirement.  Moving to an area where the cost of living is lower means your retirement savings will go farther.  If you love the Bay area, and can’t imagine living anywhere else when you retire, then you will have to considerably increasing your savings rate and / or reducing your retirement spending to make sure your retirement funds will last.

4.  Reduce Your Debt

To maximize your spending power in retirement, reduce or eliminate consumer debt (credit card, auto loans, personal loans, etc.) by the time you retire.  If you have a high mortgage payment, consider paying off your mortgage or downsizing to a smaller home.  The higher your debt, the higher your retirement expenses will be, and the less capable you will be to weather the impact of inflation in retirement.

If you are 65 years old, think back to 1990.  A gallon of gas cost $1.14, a dozen eggs cost $1.01, and a gallon of milk cost $2.80[3].  In 2019, a gallon of gas cost $3.98, a dozen eggs cost $3.22, and a gallon of milk cost $4.16[4].  Imagine where inflation will take prices over the next 30 years?  To make sure your money outpaces inflation, remain fully invested in a diversified portfolio, manage your expenses, and minimize your debt.    We can’t control  inflation but we can control how it impacts  our investments and our lives.

This content is developed from sources believed to be providing accurate information, and provided by Attune Financial Planning.  Please consult your financial, legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information only.

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