Something we have all heard about and know at least a bit about is inflation. Another way of thinking about inflation and how it impacts us is how a loaf of bread or two litres of milk are likely cost more next year than they do today. You might even have seen it in terms of package sizes too. Your loaf of bread might have been weighing 500 grams last year and cost you $5 dollars. It is likely to still be costing you $5 dollars today but the size of the loaf is now 400 grams. That means you’ll still see yourself spend more money on your weekly groceries if you were to try feed your family the same amount of food as last year. This concept is known as shrinkflation and we see it happen to a lot of our groceries including things like chocolate or your “family pack” cereal boxes.
Your savings today, is not the same in 10 years
How does this matter with your finances? In a year, not so much. But over 10-20-30 years quite a bit.
The Reserve bank of Australia’s charter is to keep inflation between 2% and 3%. The most recent annual figure is 3.8%. That means you need $103.80 now to buy the same amount that you could a year ago with $100.
Over 20 years if inflation is 2% you would need close to $150 to have the same buying power as $100 today.
Over 20 years if inflation is 3% you would need around $180 to have the same buying power as $100 today.
Account for inflation when planning your retirement
I often hear about people doing quick retirement calculations and it goes along the lines of:
“If we have say $500,000 and can earn 7%, that gives us $35,000 and we can live on that so that would be fine”.
Sounds alright doesn’t it? Or does it?
After one year you would need around $35,875 if we assume inflation is 2.5%. Still, if we earn 7% that means our $500,000 is now worth $499,125. But inflation is working in two ways here. The amount we need is going up and the real value or buying power of our money is going down.
In the above example we would run out of money in 23 or 24 years when the initial calculation was it would last in perpetuity.
What can you do? Allow for the effect of inflation because if you don’t, it will erode your retirement savings.