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Will Inflation Derail Your Retirement Plans?


A trap that even financiers and banks fall into

In the mid-1950s, my parents bought their first home with a 15-year fixed-rate mortgage. The payments were inflated – almost half of my father’s salary. By the time they paid off the loan in the late 1960s, the same payment cost as much as a nice dinner for the family!

How it happened and what this “ancient history” can teach. keep your retirement plan?

The insidious effects of inflation

If you have read a lot about retirement planning, you know that the sooner you start saving and investing for retirement, the better. This is because your investment returns over time. However, investment returns aren’t the only things that increase over time. Inflation too, and not in our favor.

How 40 years of inflation from 1978 to 2018 wiped away $1 million in purchasing power.

As you can see above, if you took $1 million in 1978 and hid it under your mattress, 40 years later that million would have bought less than $300,000 worth of goods in 1978 dollars.

That’s an extraordinary loss of more than 70% of purchasing power over 40 years! What may shock you even more, inflation averaged just over 3% per year over this 40-year period! That’s how insidious inflation can be.

But in reality it could be much worse. If you had started this 40-year period just a decade earlier, in 1968, as shown below, you would have lost over 83% of your purchasing power!

How much worse was the impact of 40 years of inflation from 1968 to 2008.
How much worse was the impact of 40 years of inflation from 1968 to 2008.

Even experts and banks usually don’t get it right

As my parents’ story shows, their lender didn’t factor inflation into the loan terms. Thus, their salary increased from almost half of the monthly salary to the cost of a restaurant dinner for five.

Similarly, if you happened to take out a 30-year fixed mortgage around the summer of 2016, you could score an APR below 3.5%. If inflation returns to its long-term average, your inflation-adjusted interest could be close to 0%, and the investors who bought your loan could lose money!

If you look at the beautiful projections created by financial planners, almost none of them take inflation into account. They will talk how much you will save each year how you will allocate investments between different asset classes, how much each asset class can return, etc. They will then give you an extremely large number of dollars that you should achieve by the time you are ready to call it a career.

What they rarely mention, mostly because they don’t think about it, is that the $1 million or more that their plan has planned for you will likely be worth pennies on the dollar by the time when you are ready to spend them!

How to beat inflation with personal retirement planning

Neither you nor I have any control over inflation (even the Fed is struggling to handle it!). The only thing is that we it is possible make it count in our planning. If you plan to retire in 40 years, budget for retirement in today’s dollars, but then multiply it by 1.03^X (that’s 1.03 to the power of X), where X is how many years you have until retirement pension. Finally, to get this projected inflation-adjusted budget to the target, multiply it by 25 (according to the famous “4% rule”).

For example, if your retirement budget is $50,000 in today’s dollars, you should plan to build a nest egg of 25 times that amount, or $1,250,000 in today’s dollars. However, with 40 years until retirement and inflation averaging about the same 3% over the past century, you’d need $50,000 × 25 × 1.03^40, or just under $4.1 million , if you count in dollars for the year you will retire.

It looks very scary, doesn’t it? However, with the nominal historical return of Art Stock exchange at ~10%/year, investing just over $8,000/year in stocks (and increasing that contribution each year by inflation) for 40 years will get you there.

Considering that even with its problems, Social Security will likely pay about 80% of your promised benefits, A $6,000 annual pension adjusted for inflation might be enough to do the job.

The bottom line of accounting for inflation

If your retirement plan doesn’t adjust for inflation, you may think you need a lot less than you actually do. It could completely derail your retirement, requiring you to cut back on spending drastically, or the risk of running out of money before life ends.

If you’re paying a financial planner to help you design your retirement plan, ask them what inflation numbers they’re assuming and what you can realistically expect to spend in today’s dollars from the nest they project for you.

Disclaimer: This article is for informational purposes only and should not be construed as financial advice. Before making important financial decisions, you should consult a financial professional.

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About the author

Ofer Ganel

My career has taken many unpredictable turns. MSc in Theoretical Physics, PhD in High Energy Experimental Physics, PhD in Particle Detector Research and Development, Research Position in Experimental Cosmic Ray Physics (including several visits to Antarctica), a brief stint at a small engineering services that support NASA, after which he started his own small consulting practice in support of NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own marriage and family therapy practice. I now use all of this experience to also offer financial strategy services to help independent professionals achieve their personal and business financial goals.

Contact me on my own website: OpherGanel.com and/or follow my Medium post: medium.com/financial-strategy/.

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