Most investors only consider the risk to their principal, which is why they favor Certificates of Deposit over non-FDIC insured investments for their most protected assets.
The risk of lost buying power is a more complicated dynamic. The dollar value of the principal stays the same, but a dollar buys less and less year after year. This happens so gradually over time. A gallon of milk increases a few cents over the course of months, and it is easy to tune out the constant, low-level increases in utility fees like electricity, shipping of goods and services, gasoline, heating fuel, and water delivery.
Inflation is insidious this way, and it varies so widely over the range of goods and services that it’s hard to gauge the true effect on an individual basis. For example, individuals paying for their major medical coverage who are experiencing any health care issue were noticing double-digit spikes in the year-to-year increases in health insurance and medical care. If health care costs become a significant percentage of purchases in any given year, the massive erosion of health care buying power can affect the risk of loss from inflation. Individuals who are young, healthy, or receiving high-quality coverage from their employers may not see health care inflation affecting their buying power nearly as much.
Noticed or not, inflation is real and can vary widely based on an individual’s circumstances. To offset inflation, your income must rise each year. Assuming you don’t go back to work, this income must come from a pool of assets that is also growing.
Inflation is dangerous, the most dangerous roadblock in retirement planning. Inflation is the retirement planner’s largest and most focused problem. Inflation must be calculated into any responsible plan.
“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman.” – Ronald Reagan
The impact of inflation: Inflation and the Purchasing Power of One Dollar
“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman.” – Ronald Reagan
The impact of inflation: Inflation and the Purchasing Power of One Dollar Average Annual Rate of Inflation
The US Department of Labor Bureau of Labor Statistics maintains an inflation calculator. Here is the link:
http://www.bls.gov/data/inflation_calculator.htm
In simple terms, inflation can be defined as either a rise in prices or a fall in the value of money. The short answer is, “An increase in the cost of things that are necessary for humans to live and enjoy life, such as bread, butter, milk, cheese, coffee, oil, shelter, clothing, medical services, chicken, cotton, and electronics. Or “a decrease in the value of money so that it takes more dollars to buy the same goods and services it did in the past.”
Looking back just a few years will show examples of how inflation can drastically affect fixed retirement income since the 1950’s inflation has increased average prices 1,000% or more as of November 2016.
Example 1: a postage stamp in the 1950s costs 3 cents; today’s cost is 46 cents – 1,600% inflation.
Example 2: a gallon of full-service gasoline cost 18 cents before; today it is $3.65 for self-service – 1,667 % inflation.
Example 3: a new house in 1959 averaged $14,900; today’s average home costs $282,300 – 1,795% inflation.
Example 4: a dental crown used to cost $40; today it costs $940 – 1,950% inflation.
Example 5: an ice cream cone in 1950 cost 5 cents; today, you’ll spend $3.50 – 5,900% inflation.
Example 6: several generations ago a person worked 1.4 months per year to pay your federal tax bill; now, it takes 5 months.
Also, in the past, one wage-earner families lived well and built savings with minimal debt, and many families paid off their home and college educations for their children without loans. How about today?
Few citizens know that a few years ago, the government changed how they measure and report inflation as if that would stop it – – but families know better when they pay their bills for food, medical costs, energy, property taxes, insurance, and try to buy a house.
Inflation is part of our lives and part of our retirement planning; it must be dealt with.
Here is a link for up to date information on current and historical inflation rates: http://inflationdata.com/
