Inflation is the rate at which the prices of goods and services rise over time. This phenomenon may seem like a plan hatched by an evil mastermind, but inflation isn’t necessarily a bad thing. It’s generally a sign that the economy is growing — and during your working years, you can usually expect your wages to rise with inflation so your spending can keep pace.
The big problem arises when you’re trying to save money for your retirement, since inflation erodes the purchasing power of the money you put aside. When inflation averages 3.5% per year (and it generally falls between 2% and 4% each year), prices double about every 20 years.
If you hope to retire at age 65, then you have to account for prices to double while you’re working and during your retirement.
Here’s how you can protect your nest egg from the destructive power of inflation, both before and after you retire:
1. Calculate inflation costs into your retirement plan
Retirement planning calculations often start with the amount of money you think you’ll need as income per year. For instance, you might decide that you can live comfortably on $40,000 per year in retirement.
However, if you don’t factor in the costs of inflation, you might save enough to live on $40,000 each year — but the money won’t go nearly as far, and you might still find yourself struggling to make ends meet.
That’s why you must include an inflation calculation in your planning. Financial Mentor offers a comprehensive calculator, which can help you determine how much of a bite inflation will take from your savings.
2. Invest wisely
Putting your money into more aggressive (that is, risky) investments, like stocks, can feel overwhelming. It may seem much safer to put your money into CDs and money market funds that protect the principal — except that the principal will be worth less money by the time you access it. (And yes, you’re forgiven for feeling like you can’t win with investing.)
However, it’s possible to invest your money wisely by diversifying. Allow some of your money to earn interest more aggressively in stocks and equities, while some of your money stays in safer investments like bonds (and even CDs.)
3. Remember that your retirement date isn’t the end
Not only do you need to recognize that your cost of living may double in the years after you retire — after all, we’re all living longer, and making it to age 85 after a retirement at 65 is hardly out of the ordinary — but you also need to remember that retiring doesn’t mean you’re done investing.
During your retirement, you’ll want to monitor your investments and re-balance your portfolio regularly, so you can continue to see your money grow even after you’ve stopped contributing to your retirement accounts. If your money remains diversified in your retirement, you can still have some of your nest egg placed in more aggressive investments. Those will be the investments you’re waiting to access until you’ve been retired a couple of decades.
The Bottom Line
Inflation does more than just make old prices for goods seem quaint; it can devastate your savings if you don’t plan ahead for it. Make sure you include an inflation calculation in your retirement plans.
How have you adjusted for inflation in your retirement plan?
- E*TRADE IRA - Official Site