08 ~ Investment,finance for businesses

08

 

EIGHT

Rising inflation may threaten your standard of living.

It's not always expenses that will eat into your savings. Sometimes, it will simply be the rising cost of living.

Inflation in the cost of goods and services, as measured by the Official Consumer Price Index (CPI), has averaged about 3% a year. As you can see from the chart below, we are in a period of very low inflation. You can also see that the rate of inflation varied quite a bit over the 30 years spanning 1980-2010. That's why it's smart to plan for inflation to raise the cost of living about 3% per year.

While 3% may not sound like much, here's how it breaks down. If you need $50,000 per year to live as a retiree today, assuming a 3% inflation rate, in 25 years you'll need $100,000 per year to maintain the same standard of living. That's because every year, the value of your savings will fall by 3%, which adds up to reducing your buying power by 50% over 25 years. Social Security is adjusted for inflation, giving you some measure of protection, but keep in mind your specific inflation rate might be different from the general inflation rate as a result of rapidly rising health care and long-term care costs.

If you're having trouble wrapping your head around this idea, here's another example. The table below shows the cost of a cup of coffee, a movie ticket, a mid-range sedan and the average home price in 1980 dollars, today's dollars and the projected cost in 2040.

RISING COSTS

COMMON  

EXPENSES

 

1980

 

Today

 

2040

 

COFFEE

$0.45

$3.16

 

$6.05

 

$2.69

 

$9.18

 

$17.59

 

CARS

$7,210

 

$35,444

 

$67,914

 

HOMES

$70,725

 

$250,400

 

$479,792

 

 

As you can see, you have to keep your investments growing throughout retirement to keep your standard of living consistent. While investing in CDs and low-yield, low-risk bonds may feel safe because your principal is protected, that doesn't take inflation into account. These low risk accounts only assure a reduction in your buying power over time.

Growing your savings to keep up with inflation, while simultaneously making withdrawals is complicated, but with the right plan in place, it's achievable.





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