How Inflation Affects Your Retirement
Posted 03 Apr 2019 by Natalie LeBlanc
You’ve certainly noticed groceries don’t cost what they used to. Neither did your house, or car, or the gas for your car.
While price fluctuations are normal, a sustained increase in the prices of consumer goods (as measured by the Consumer Price Index, or CPI) is what’s known as “inflation”. The most recent year’s pace of inflation was 2.1% -- meaning that your household costs are probably about 2.1% higher now than they were this time last year.
Why should I care about Inflation?
Inflation is one of the components of the economy that is talked about in the news rather often, but why should you care? Simply put, inflation tells you how much more money you’ll need next year to buy all the same things you did this year.
The idea behind the theory is this: If you have $20 in your pocket today, a year from now that $20 will only be able to buy you what is currently $19.59 worth of goods*. The prices of the things you’ll want to buy are going to go up, which will make it seem like you only had $19.59 saved. You will only have $19.59 in “today’s dollars”.
After one year the difference isn't much, only $0.41. Compound inflation over 20 years, however, and you're going to need $9.72 more to buy the same goods as today! That's almost 50% more, 20 years later.
What should I do about inflation?
Inflation effectively illustrates how the real value of your dollar goes down over time, not due to currencies but the fact that prices increase. The only way to mitigate the risk of inflation is to increase your money supply over time as well.
Obviously, stuffing your money under your mattress is not going to increase the value of that money over time. Investing it may.
Investing to beat inflation
Even some of the most basic investment products, like interest-bearing savings accounts, help mitigate inflation risk. Earning 1.5% interest certainly beats 0%! A good investment will realize returns higher than that of inflation to, at least, preserve the value of your dollars. Given that inflation last year was 2.1%, that means aiming for an investment return higher than 2.1%.
Take note however, the CPI is not always in a state of inflation, and even when it is the rate of inflation changes regularly. It is a good planning practice, however, to plan for higher expenses than lower expenses. Better to have too much money than too little, right?
*Based on 2.1% inflation rate published by msn.com