This is part three of a five-part series on Retirement Planning.
Part 1: Years to Retirement
Part 2: Savings Rate
Part 3: Inflation
Part 4: Social Security
Part 5: Large Asset Ownership
Never in my life have I wished for a time machine more than I did the day I learned about inflation.
“You are telling me that by the time I can earn enough money to get the stuff I want, that stuff will cost more?… How will I ever be able to afford to buy anything?” It’s true. I was a very melodramatic child, and my mother was a saint.
Regardless of that, inflation is one of the most important principles you need to understand. That’s because inflation isn’t just an idea or a theory, it’s an economic reality. And moderate inflation is a byproduct of a healthy economy.
As a basic definition, inflation is the rate at which the average prices of goods and services in an economy increases over a period of time.
Here are some examples of what inflation has looked like in the US over the past 95 years:
| Year | 1924 | 1943 | 1952 | 1968 | 1978 | 1983 | 2019 |
| Income | $2,196 | $2,041 | $3,850 | $7,844 | $16,975 | $21,073 | $63,179 |
| New House | $7,720 | $3,600 | $9,075 | $14,975 | $54,749 | $82,600 | $296,828 |
| New Car | $265 | $900 | $1,754 | $2,822 | $5,405 | $8,577 | $36,718 |
| Average Rent | $18 | $40 | $80 | $130 | $260 | $335 | $1,405 |
| Harvard Tuition | $250 | $420 | $600 | $2,000 | $4,450 | $8,195 | $46,340 |
| Movie | $0.11 | $0.35 | $0.70 | $1.50 | $2.00 | $2.50 | $9.11 |
| Gas | $0.15 | $0.15 | $0.20 | $0.34 | $0.63 | $1.17 | $2.73 |
| Postage Stamp | $0.02 | $0.03 | $0.03 | $0.06 | $0.15 | $0.20 | $0.55 |
Inflation: A Retirement Killer
Inflation is a retirement killer. This is something many people under-represent, or even forget to represent completely.
Let me give you an example:
The US has experienced 3.5% inflation on average for as long as we have had a good inflation measurement. The Federal Reserve System’s goal is inflation at 2.5% per year, but in recent years, the inflation rate has been below this goal, just shy of 2%.
While inflation is a small rate, don’t let that trick you. In the long term, it has a very big effect.
The following is a table shows you just how much money you will need in the future to equal the buying power of $50,000 today:
| 3.5% Inflation | 2.5% Inflation | |
| 2020 | $51,750 | $51,250 |
| 2025 | $61,463 | $57,985 |
| 2030 | $72,998 | $65,604 |
| 2035 | $86,699 | $74,225 |
| 2040 | $102,972 | $83,979 |
| 2045 | $122,298 | $95,015 |
| 2050 | $145,252 | $107,500 |
| 2055 | $172,513 | $121,627 |
| 2060 | $204,892 | $137,610 |
| 2065 | $243,347 | $155,693 |
People often forget that future expenses come with a higher price tag. When you are replacing income, you need to make sure you are not replacing an income amount, but an income’s buying power. If your current income is $50,000, then that income will have half the buying power ($25,000) by 2040 or 2050 (depending on inflation rates). Whereas if you replace buying power, then you need to make sure you are planning on having $100,000 available per year in 2040 or 2050, or more if you retire later.
The other thing people don’t often take into account, is the length of retirement. Inflation will continue to increase during your retirement years. At a 3.5% rate, you will need $100,000 in 2040 to replace a $50,000 income in 2020, but if you plan on 20 years in retirement, you will need $172,000 to $200,000 per year just to maintain the same $50,000 of buying power toward the end of your retirement.
How Inflation Impacts Your Financial Plan
Make sure you are adjusting your earnings and savings goals not only for inflation between now and retirement, but inflation during retirement. The impact of inflation can be mitigated, but it requires deliberate planning.
Afterword
For the number and financial nerds out there, I have taken the inflation table from above and broken it down so the first line now shows the average earnings per hour (average labor rate), and each line below indicates how many average labor hours it would take to purchase each item.
Or in other words, the value of each of these outside inflation terms. From this, you can see the cost of each one of the items in terms outside inflation, and in the context of subsequent technical innovations of the time period.
| 1924 | 1943 | 1952 | 1968 | 1978 | 1983 | 2019 | |
| Avg Income | $1.10 | $1.02 | $1.93 | $3.92 | $8.49 | $10.54 | $31.59 |
| Avg New House | 7,031 | 3,528 | 4,714 | 3,818 | 6,451 | 7,839 | 9,396 |
| Avg New Car | 241 | 882 | 911 | 720 | 637 | 814 | 1,162 |
| Avg Rent | 16 | 39 | 42 | 33 | 31 | 32 | 44 |
| Harvard Tuition | 228 | 412 | 312 | 510 | 524 | 778 | 1,467 |
| Movie | 0.10 | 0.34 | 0.36 | 0.38 | 0.24 | 0.24 | 0.29 |
| Gas | 0.14 | 0.15 | 0.10 | 0.09 | 0.07 | 0.11 | 0.09 |
| Postage Stamp | 0.02 | 0.03 | 0.02 | 0.02 | 0.02 | 0.02 | 0.02 |
To me, this represents where our priorities are as a society. In instances where relative prices (labor hours) go down, we can look at these as “inferior goods,” or goods and services we want to consume less of as our income increases. In instances where prices (labor hours) spike, these can be considered “luxury goods,” or things we aspire to consume more of as a society. If it neither increases or decreases, these are normal goods, or things we expect to always have.
Homes, for example, have increased significantly over the years. This is mostly due to increasing construction standards, increased average home size, and additional technologies in our homes. Technologies like plumbing, electricity, HVAC, internet, home automation hardware etc. Each of these technologies makes our lives better, but also more expensive.
The same is true with vehicles. The amount of time spent in vehicles has increased significantly from 1924 to today. With that increase, we as consumers have wanted our cars to be larger, safer, perform better, and be more comfortable. This has increased vehicle costs over the years. While gas, on the other hand, hasn’t increased in relation to labor hours.
You’re probably wondering, “Alright, this is cool, but what’s the point of this exactly?”.
Aside from being interesting, well at least to me, this has an application to personal finance. From a budgeting perspective, we can identify places where we can save the most money: consuming less luxury goods. The areas where the relative price has increased also identifies the places where there is the most relative cost to remove.
If you want to save the most, I’d recommend living like it’s 1924. No home automation, no central air, drive an older car, and find a school with modest tuition. The availability of inferior products in these markets will yield a marginally acceptable product for a marginally smaller price (even though you will be consuming less than you may prefer to).
On the flip side, where relative costs have decreased or remained the same, we see items where finding a bigger, better product is more difficult. These products and services are more democratized and your money will go much further. Finding simple pleasures in these areas helps us find places we can enjoy our money where our money will go further.
Starting your financial future today
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