Can you live comfortably on half of what you are living on now? I guess the bigger questions is, would you want to? That’s the question you have to ask yourself if your retirement plan ignores the effects of inflation.
When you’re figuring out how much money you'll need for retirement, you’ve got to forecast a few inputs that you can’t really predict with certainty. You won’t really know whether you were right about your predictions until after you’ve gotten to the end, which is a little late for retirement planning. You’ll need to guess how long you’ll live, what return you’ll make on your investments, and how much you plan on spending over those retirement years. And spending will include inflation, whether you include it or not.
According to U.S Census Bureau data I can expect to live another 33 years. That seems a little low to me. I’m pretty healthy and two of my grandparents lived well beyond 82. Of course you never know what is going to happen, but I’m planning for 100 birthdays, just to be safe. The last thing I want to do when I wake up on my 83rd birthday is have to go look for a job.
Return on Investments
You can’t really know with certainty how much you’re going to earn on your investments either. Depending on your risk-tolerance and your resulting asset allocation though, history can give you a little bit of guidance. And when you use William Bengen’s Safemax approach, you’re betting that you will experience the worst historical combination of returns and inflation over your projected time period. So that should provide some comfort. Unless of course you think things are going to be even worse. In which case, you should adjust for that.
If you’re basing you retirement plan on double-digit expected annual returns though, I’m going to predict that you’re not going to make it to the end with enough. (Or alternatively that you wind up at Club Fed for insider trading, which of course is another way to take care of your retirement.)
And if your plan to beat inflation is simply to shave down expenses each year by the inflation rate, you’d better be prepared to spend only half of what you are spending today.
The annual inflation rate has been pretty low over the last couple of decades, between 2 and 3%. Some people think that the Federal Reserve’s current easy monetary policy is going to cause those numbers to skyrocket in the future. But even in these relatively low inflationary years, the cumulative effect of inflation over the last two decades is almost 82%. The basket of goods that cost you $100 in 1990 would cost you $182 today. Because some items are going up faster than other items, your individual basket may vary.
In my case, health insurance has been going up by double digits each year, and this line item is a pretty hefty chunk of my basket of goods. My retirement plan assumes a 3.5% inflation rate, which would roughly double my expenses two decades from now. I can try and combat some of this, sure. I just bought a car that gets double the gas mileage as the old one, so there, I cut that expense by half. But 20 years ago gas was about one-quarter what it is today, so after inflation, I’m still behind on that line item.
As inflation goes up, you can switch from beef to chicken, wine to water, and dining out to dining at home. You can give up vacationing, concerts, and sporting events. You can downsize from two cars to one, from four bedrooms to two, or move from California to Kansas. But what do you do if you already live in Kansas with one car and two bedrooms? Or what do you do if the things you give up don’t offset the increased cost of health care, long-term care, or things you have to pay others to do because you can’t physically do them anymore?
Even if you can slice and dice to try and whip inflation, the question is, do you really want to bake that reality right into your retirement plan?
Can’t keep track of my non-existent posting schedule? Subscribe—it’s free!