“Inflation is when you pay fifteen dollars for a ten-dollar haircut you used to get for five dollars when you had hair.” -Sam Ewing
“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” -Ronald Reagan
Despite these witty quotations, no one could say it strongly enough – when living on a fixed income, inflation has a profound impact on your quality of life. The American Heritage Dictionary of the English Language defines inflation as, “A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.” Basically, inflation makes goods and services more expensive and decreases the value of your money.
Most experts feel safe recommending that individuals calculate their retirement needs using an 8 percent inflation rate. But, it is important to understand that we have seen (as in the late seventies, eighties and early nineties) sustained inflation rates of around 12-17 percent! Failing to account for the effects of inflation is a very damaging mistake. Perhaps the following example will help you understand the real world implications.
These scenarios assume that you now require Rs. 12,00,000 a year to maintain your lifestyle and would like to maintain that standard of living in retirement. An 9 percent inflation rate is used — the recent historic average (neither low nor high):
- If you need Rs 12 Lakh a year to live now (your age is 58 years), you will need Rs28.40 Lakhs a year by the time you are 68 years old, to support the same standard of living.
- Rs 52 Lakhs a year is the amount of money you would at age 75(if you retired at 58).
- And, if you retired at 58 and lived to be 85 years old – another 27 years, you will need Rs 1.22 Crores a year!
The fast developing medical technology is helping in longer life span. No wonder if the normal life expectancy increases by 10 to 15 years over next decade or two. That will add more fiscal stress to retirees who couldn’t plan ahead well. Secondly, predicting the future inflation is an impossible task. One needs to continuously attune the portfolios with rising or falling inflation trends. Any mismanagement will lead to loss of wealth and purchasing power. Medical facilities will keep us alive longer, that’s a good news. But, they will continue to be expensive is a bad news. Retirees need to plan well in advance for medical expenses too.
Inflation can act as double-edged sword. Inflation on the higher side will diminish your purchasing power whereas if it is too low it can reduce returns on your savings/investment. Inflation erodes your purchasing power. It makes your Savings go down in value. Think of a 8% inflation rate as a 8% tax on your money.
A compact retirement plan should factor for two types of overhead: fixed and social. Fixed expenses like food, medical bills, utilities, insurance and other miscellaneous costs. Social expenses like entertainment, travel, and other activities that you desire to experience for as long as you live. These expenses will keep on rising over your lifetime.
The good news is that some pension programs (though increasingly few) adjust your income for inflation. The bad news is that if you are living in retirement by withdrawing from investments or savings, then the value of your money will dramatically decrease overtime. You will require far more money to support your lifestyle in the future. These insights will go a long way in helping to make sure you aren’t facing INFLATION MONSTER in your retirement phase.