Leak #3 in Your Piggy Bank

Over the past few weeks we've explored two leaks in our piggy banks. Today we discuss the third leak: Inflation.

Leak #3: Inflation

Planning in the present when needs are in the future must always account for inflation. Inflation is the third leak in your piggy bank. Even though you may continue to save and invest your piggy bank may not be growing in real dollars after adjusting for inflation. We call the dollars before inflation nominal dollars. After adjusting they become real dollars.

In all my years providing planning services I have seldom discussed retirement income when the client fully appreciated the challenge inflation presents. Thinking in the present when planning is never a good idea. Present value dollars are not worth as much in the future. We all know it but somehow do not plan for it.

Planning for my Future

I will use an example using my own personal experience.

Shortly after graduating from Wharton, I began planning for my future financial security, I decided arbitrarily that I needed $1,000,000 when I planned to retire at age 65. In 1969 $1,000,000 was a huge sum of money. My wife was teaching. Her salary was $5200. I was earning about $6,800.

You would think a Wharton graduate would be smarter than I was. You see I was thinking about dollars in the present when I should have been thinking about the future value of those dollars. I was twenty-four when I started my plan for retirement at age 65. I allowed myself 41 years to achieve my goal. While I allowed more than enough time, I did not consider inflation.

The million dollars I envisioned in 1969 would have needed to grow to $5,941,580 to have the same purchasing power for my retirement. As most of you know, I did not retire at 65. Today, twelve years later in 2022, it would need to be $7,964,468 to buy the same goods and services as I imagined I needed in 1969.

Why?

The reason is inflation. It is always there. Some years it may only be 1-2%. Other years like now it may be much higher. Over the past 12 months it has been about 8.6%. Since I began working after college in 1969, it has averaged 4.44% each year through my projected retirement age 65. In the twelve years since my planned retirement [now age 77] inflation has averaged only 2.47%. But in the last year of the twelve it was 8.6%.

$1 in 1969 is equivalent in purchasing power to about $5.94 in 2010, an increase of $4.94 over 41 years. The dollar had an average inflation rate of 4.44% per year between 1969 and 2010, producing a cumulative price increase of 494.16%. If I had delayed retirement to age 70, the inflation rate over my working lifetime would have been 4.23%. At age 70 the dollar equivalent for my dream $1,000,000 would have needed to grow to $6,450,000. Today, about 7 years later, it would need to be $7,964,500.

As I have said many times I am not planning to retire. I really enjoy working and helping our clients achieve their financial goals. I have learned that inflation is pervasive and unrelenting in its destruction of our dollars’ purchasing power. It is much easier fighting inflation with a paycheck than it is on a retirement income.

Inflation never goes away. Interestingly over the past 12 years since 2010, the inflation rate did slow down but it never vanished. Eleven of those years enjoyed below average inflation and then about one year ago, it exploded.

To summarize, we have identified three leaks in our piggy banks:

1. Not investing sufficiently in growth and investing too much in fixed income.
2. Not earning what we expect. Dalbar studies show how most individual investors consistently earn less than their actual investments because of timing, switching, and selling during times of stress. We describe the behavior as the "buy high, sell low" syndrome.
3. Inflation

Next, we will discuss timing and its cost to investors.

Sincerely,

Thomas J. Curran, Founder & Co-Chief Executive Officer