Planning for retirement can inspire a range of questions and concerns. From budgeting the right workplace contributions each month to ensuring you’re investing in low-fee funds, it can take time to understand it all.
However, if there’s one threat you should really comprehend when it comes to retirement planning, it’s inflation. That’s because it’s a financial phenomenon that forces you to plan in the first place.
Below, we take a look at inflation to explain what it is, what it means for your financial planning and how you can help protect yourself against it.
Inflation essentially describes the fact that the cost of goods – such as groceries and rents – will rise over time. It’s why $1 today can buy you more coffee, for example, than what it can buy you tomorrow.
Some inflation is good – it’s often a sign of a strong economy. It could also mean that, in 30 years, that $1 won’t be able to buy you much — if any — coffee at all.
1. Inflation impacts your spending
This inflationary dynamic has drastic implications on how much you can spend in retirement. If you look at your current budget, say you spend $20,000 a year for food and housing costs. If you hope to spend the same amount in retirement, you would have to drastically decrease your day-to-day expectations. That’s because that $20,000 won’t go as far in 20 years.
The average annual inflation rate over the long term is 3.22%, according to Inflationdata.com. This means that, in 20 years, prices of goods will essentially double. In order to live the same lifestyle you have now, if you’re retiring in 20 years, you would need closer to $40,000 when budgeting for food and housing.
2. Without risk, your money won’t grow fast enough
In order to get past this hurdle, it means you have to take on some risk in your savings plan. It’s why you can’t simply take your retirement savings, place it under a couch cushion and wait to use it when you’re ready. You want your money to grow faster than inflation.
To do so, you may consider placing some of your savings in stocks. If you’re enrolled in your company’s 401(k), there’s a good chance a portion of that portfolio has stock exposure. While this means you could see some more potential movements in your savings, over time, the market has historically far outpaced inflation. According to data compiled by NYU’s Stern School of Business, the average return for stocks from 1928 to 2015 was 9.50%.
3. Longer lifespans, higher medical costs
The longer you live, the more you have to worry about inflation, because over more years, inflation has more time to grow.
Our overall lifespans have significantly increased over the past century. But with extended life comes more medical expenses, which also rise with inflation.
Health care costs could rise close to 6% a year over the next decade, according to the Centers for Medicare and Medicaid Services. A 55-year-old couple retiring in 10 years could have total lifetime health care costs of $463,849, according to a study by HealthView Services. Individual situations will vary, and not everyone will pay this much, but it is a baseline figure to consider when planning for your future.
Even those nearing retirement may want to keep some portion of their portfolio in equities or another investment that has the potential to grow over the 20 to 30 years of retirement, so their assets may see returns that beat inflation.
Inflation is a fact of life. But by understanding how it can eat your savings, you can plan and help protect your money from it. By increasing your risk levels, you help give your money the potential to grow faster than inflation.
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