Retirement, Inflation, and Purchasing Power
What Exactly Is Inflation? And How Does It Impact Your Retirement Savings?
You often hear that your retirement savings need to keep pace with inflation. But what exactly is inflation, and why does it matter so much for your financial future?
Simply put, inflation is the general increase in prices for goods and services over time. In contrast, deflation is the decrease in prices. As prices rise, the purchasing power of your money decreases. For example, if inflation is 10%, something that cost $1 last year might cost $1.10 this year.
In the U.S., the average rate of inflation has been about 3.29% per year from 1914 to 2016. But inflation can vary widely. In June 1920, inflation hit an all-time high of 23.7%, and by June 1921, it had plummeted to -15.8%.
How Does Inflation Affect Your Retirement Savings?
Inflation gradually erodes the value of your money. Here's a simple example:
If you have $100 today and inflation averages 3% per year, in 20 years, that $100 will only buy about $67.30 worth of goods. In 35 years, it would be worth just $34.44 in today’s dollars.
This is why it’s crucial to consider inflation when planning for retirement. If your savings aren’t growing at a rate that keeps pace with inflation, your money may not last as long as you expect.
How Is Inflation Measured?
Every month, the Bureau of Labor Statistics (BLS) releases reports tracking inflation through two key indexes:
Consumer Price Index (CPI):
Measures the average change in prices from the consumer’s perspective. It includes essentials like food, clothing, gasoline, and healthcare.Producer Price Index (PPI):
Measures price changes from the seller’s perspective. It tracks the average change over time in the selling prices received by domestic producers.
Both indexes offer insights into rising or falling prices and help measure the impact of inflation on everyday life.
The Federal Reserve’s Role in Controlling Inflation
Until the Federal Reserve System was established in 1913, the U.S. lacked a central banking system. The Fed was created with three core mandates:
Promote maximum sustainable employment
Stabilize prices
Moderate long-term interest rates
To control inflation, the Fed uses monetary policy, primarily by adjusting short-term interest rates.
If inflation is expected to rise, the Fed may increase rates to slow borrowing and spending.
If the economy slows too much, the Fed may lower rates to encourage borrowing and spending.
The Fed currently aims for 2% inflation (measured by the Personal Consumption Expenditures Price Index, or PCE) as part of its strategy for economic stability.
Why Inflation Matters for Your Retirement Strategy
Inflation can significantly impact the value of your retirement nest egg. Even modest inflation rates, over time, reduce your purchasing power.
For example:
At 3% inflation, you’ll need twice as much money in about 24 years just to maintain the same standard of living.
If your retirement plan doesn’t account for inflation, you may find your savings falling short when you need them most.
What Should You Do?
It’s important to build a retirement strategy that factors in the effects of inflation. Here are a few key points to consider:
Assume a realistic inflation rate in your planning (historically around 3%).
Invest in assets that tend to outpace inflation, such as stocks, real estate, or inflation-protected securities.
Review your plan regularly to adjust for changes in inflation expectations.
If you want help developing a retirement strategy that prepares you for inflation, talk to the financial professionals at NEST Financial. We can help ensure your savings are designed to stand the test of time.
Visit our website to contact us.