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Is Inflation Stealing Your Money? The Effects of Inflation on Your Retirement

Phil Town
Phil Town

Inflation is something that many people completely forget to factor in when calculating how much money they're going to need for retirement.

Most people tend to assume that if you want to live on say, $50,000 a year for the rest of your life you need to multiply that number by 30 years and that's how much you need. What they don't take into account is inflation.

This means that to retire, you may need much more than you think. The small percentage may not seem like a lot, but over time, it adds up.

Inflation can be detrimental to your retirement if you don’t take it into account. Let's discuss how inflation affects your retirement.

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What is Inflation?

Inflation is a devaluing of a currency's buying power. It occurs over time as the government pumps money into the economy and there's a larger money supply buying a relatively fixed amount of stuff.

As the money supply grows, people feel like they have more money, so they're willing to pay more for things. When there's a lot of inflation, wages tend to increase and people then feel like they've got even more money, so they're willing to pay a little bit more for a Coca-Cola.

When I was a kid Coca-Cola was $.10, and it actually had real sugar in it. Today, you get a different kind of Coca-Cola and it costs $1. Think about that for a second. $.10 doubled up to $.20. Then it doubled to $.40. Then the price doubled to $.80. Now it's over $1 a can. There are over 3 1/2 doubles in the cost of a Coca-Cola since I was a kid. We're talking about 50 years ago.

Imagine if my Dad was making $10,000 a year back in the 1950's and his income increased by 3-1/2 doubles, he'd be making $20,000, $40,000, $80,000 and another half would be $120,000 a year.

What's interesting though, is that a lot of times our wages haven't kept up with overall inflation.

(By the way, I’m using the Rule of 72 to get these numbers, which you can read about here.)

How does Inflation Work?

The Effects of Inflation on College Tuition

Take what's gone on with colleges as a result of the Federal Government providing backed loans to banks. The Federal Government will cover the downside if you don't pay your loan. Because of this, banks are willing to lend you any amount of money to go to college. As a result of that, all the colleges just gradually keep raising their prices.

When I went to school after Vietnam in the 1970's, I went back and I earned my way through college. Now, inflation has taken the price of a college to insane heights. It's gone up at 8% a year. What that means is that since 1970, 8% a year has doubled the price of college every 9 years for 45 years.

If I paid $1,000 to go to school, what are you going to pay?

Well, double the price of college 5 times, $1,000 to $2,000, to $4,000, to $8,000, to $16,000, to $32,000.

Wages haven't kept up with that at all.

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The Effects of Inflation on Your Retirement

Let's talk a little bit about how you factor inflation into the number that you're calculating for your retirement.

Let's say you're 50 years old. You want to retire in 10 years at 60 and we'll figure 30 years in retirement and you’re putting money into a 401(k). Let’s assume you started with $100,000 today in your 401(k) and then contributed $2,000 a year into it because you’re putting your kids through college and that’s all you can put away.

In 10 years, you’ll probably make around 6% in your 401(k) (if your employer isn’t matching your money). I think a reasonable inflation rate's probably going to be about 3%. What this means is that in 10 years, when you’re ready to retire, at 6% with an inflation rate of 3%, you end up with $205,000 to retire on.

Let's assume that you're going to live on $50,000 a year. You've got $205,000 right now, but 10 years from now it won’t be worth that at all. Inflation affects everything including the costs of living, your $50,000 is going to be $67,000 a year to live that same basic $50,000 a year lifestyle. Even if you keep investing the money at 5% or 6%, inflation continues at 3%.

How many years will you be able to live in retirement before you completely run out of money, spending only $50,000 a year in today's dollars? The answer is 3 years.

If you were to not learn how to invest, you’d need to come up with another $1.3 million to live on for 30 years.

I know you're reading and thinking, "That can't be right." But it’s true, and that’s what inflation is stealing your money.

How to Get Compound Interest to Work For You

If you change your 6% return to 15% you’re going to make a lot more money. 15% is in the range of a return that’s doable for any investor who doesn’t spend a ton of time investing.

What happens then? We're going to keep all the things the same, but we're going to increase the rate of return to 15%.

At that point, your number becomes $540,000 and you're only short about $96,000 to make it all the way those 30 years of retirement.

You're going to have to learn how to make 15% a year or you're never going to get there, this is even more important if you are investing during inflation. The beautiful thing about learning how to do Rule #1 Investing, is you can start with relatively small amounts of money. If you can achieve a 15% rate of return (which is completely doable) and save a little bit of money each year, you're going to be okay.

I guess there is another option. You could love your job so much that you never want to retire. But, for most people, they work in a real 9 to 5 job. That's not the dream they have for themselves.

If you're like that, you want to retire comfortably someday, you’ve got to make sure you're paying attention to both inflation rates and taking into account how much this is going to affect your overall savings and investment growth over 10 years.

To learn how much inflation could be impacting your retirement and know how to combat rising prices, download my Inflation-Ready Checklist.

How to Pick Rule #1 Stocks

5 simple steps to find, evaluate, and invest in wonderful companies.