Although it’s rarely discussed, this quiet, boring, little topic of inflation is actually the single greatest threat to your retirement. Stated simply: Inflation is a retirement–eater that will whittle away the value of your retirement funds, year after year.
This level of threat presents an increased risk for women (vs. men) since we tend to live so much longer (and often with a smaller amount of savings). So, I really want to bring this up so that you begin giving it some considerate thought. The earlier you begin planning for it, the better off you will be.
There are at least two aspects of inflation to understand:
The average national inflation rate:
If you are in the US (which has, historically, had one of the most stable currencies in the world), check out US Inflation Rate History to get some ideas. You will see that the annual inflation rate has, at times, been less than 1% and as high as 18.1%. Since 2000, the inflation rate has averaged under 3%. Despite this fairly stable rate over the past couple of decade, it’s important to experiment with higher inflation numbers to see how they affect your plan. An increase in inflation of just 1% (especially a long-term, sustained increase) can have massive changes on your financial security
If you are outside the US, then do an online search on terms like “annual inflation rate” or “average annual inflation” + the name of your country. You can also check out current global inflation rates (and then feel very grateful if you don’t live in Venezuela or South Sudan where inflation rates are absolutely devastating).
Inflation rates will vary widely by country and are deeply tied to things like:
- political stability and the ruling political party
- monetary policy
- ability of the nation to quickly adapt to global market changes
- if the currency is pegged (Investopedia or other site) to a larger nation’s currency like the US dollar or the Euro
- how easily new businesses can sprout up as competition.
All that is to say that you should only use your own country’s average inflation rate in your projections.
Your personal inflation rate:
This one is harder to determine if you haven’t already been tracking your expenses (by category) for years. If you are one of the lucky few, you can look back over your monthly and annual expenditures from years past and see how much your own costs actually increased.
In our case, I have been tracking these numbers for years. So, I am able to clearly see that our personal inflation rate is actually lower than the national rate. The reason for this is that we are always making new financial choices to control costs – which you are likely to be doing, as well.
Example #1: About 5 years ago, we switched cell phone providers to dramatically cut costs. We left our exorbitant Verizon cell phone plan that ate up $175/mo for just 2 phones. We switched to Airvoice ($10/mo.) for one cell phone that regularly had access to free wifi + a $25/mo. plan with T-Mobile for the other phone. We purchased unlocked Android phones and said farewell to our iPhones.
Example #2: To save on food costs, we learned how to use Costco more wisely. We also reviewed our restaurant spending patterns and chose to stop ordering drinks, share meals on occasion, and not go out as frequently.
Individuals and families who consistently make changes like this every year will likely find a lower personal inflation rate (than the national average).
In your younger adult years, it’s fairly easy to keep some control over some of your largest costs (housing, food, and medical). As you age, marry, or have children, you may no longer wish to have roommates who never help clean the house. You will likely have to give up ramen and high-carb, low-cost foods for health reasons. And, you or your family may need many more doctor visits than in your 20’s and 30’s.
Additionally, when you get into your final 10 to 20 years, your mind might not be so sharp. Shopping for new service providers could become too much of a mental challenge. Bills are likely to become increasingly confusing. As a result, it’s highly unlikely you’ll still be able to optimize all your costs and keep a lower personal inflation rate. So, calculating your own inflation rate should always err on the side of ‘rounding up’ to allow for plenty of changes in life.
When I run our standard calculations, I tend to use 3% – which is considerably higher than what I currently see happening in our own family. For me, this gives a small buffer of safety and increases the likelihood that our financial independence projections will work out as planned.
For more extreme inflation projections (like 5%-10%), I look to a couple of strategies to help mitigate it:
Domestic relocation: Moving to a less expensive city – permanently or temporarily (until inflation stabilizes and costs become more manageable).
International relocation: Similar to domestic relocation, this requires moving. However, some of the financial assets left behind in the home country could still be losing value due to the high inflation.
Renting out room(s) in your home: Real estate tends to hold some value in inflationary environments. If you have a fixed rate mortgage, the monthly cost of your mortgage payment would become even more affordable in such an environment. (Todd Tresidder over at FinancialMentor.com covers the mortgage topic in extreme depth and makes an important point about how having a fixed interest rate on your home could actually end up paying you to carry the mortgage. Weird, but true!)
There are also many other steps you could be taking now to mitigate your own inflationary risks:
Remember: When calculating your Financial Independence or Retirement numbers, be sure to test out different rates of inflation to see how they impact your plan. Then, take steps now to control your inflation risk. Doing so will give a you added peace of mind!
Let me know if this article was helpful for you (or if you have any questions) in the Comments section below!