How Keeping Pace with Inflation Will Affect Your Retirement

Physician's Money Digest, June 2007, Volume 14, Issue 6

Whether your retirementis years away or justaround the corner,inflation will exert amajor influence on your future economichealth. Ignore it at your own peril.

If you've been around long enoughto remember McDonald's 15-cent hamburger,you may feel nostalgic when youshell out 85 cents for that same treattoday. Surprise. That same hamburgerwould sell today for about $1.03 if itkept pace with inflation. That popularproduct is cheaper today than it was 50years ago.

Direct Comparisons

Unfortunately, the bargain-price aberrationin such products as McDonald'shamburgers doesn't extend throughoutyour personal universe of products andservices. During the Great Depression, afirst-run movie ticket sold for 15 cents.With inflation factored in, a movie ticketshould cost $2.03 today. With pricesnow running at $8.50 or higher, it'scosting you a lot more to visit the localmovie emporium than it did back in thedark days of the Depression (and don'tforget today's $2.50 Coke that used tocost a nickel).

As a physician, you're well awarethat costs for medical services and malpracticeinsurance have risen at a pacefar in excess of the average inflationrate. College tuition is another expensethat is mind-numbingly higher than indays of yore. So what does all this haveto do with your retirement? Plenty.

Inflation Never Lets Up

As the chart shows, inflation canvary wildly from one year to the next.However, regardless of its variations,inflation continues its work relentlesslyyear-after-year. Even the modest inflationrate of recent years takes a significanttoll over time. After 10 years of 2%inflation, that dollar bill in your pocketnow will be worth only 82 cents intoday's dollars.

Here's an example of how inflation isaffecting your life right now: If you paid$60 for a week's groceries in 1985,you're paying about $106.48 for thosesame items today.

If you paid $18,000 for a new car in1987, it would cost you approximately$31,944 to replace it with a similar2007 model. Ten years from now, acomparable new car will cost you about$40,891 (assuming a modest 2.5%inflation rate). These figures assumethat the increases in costs for thoseitems keep pace with the current rate ofinflation. In practice, the inflated priceof specific items may be higher or lowerthan the average.

If you'd like to gauge inflation'seffects on some of your personalexpenses, log on to This inflation calculator adjustsany given amount of money forinflation from 1800 to 2005.

Many financial planners estimatethat you will need 80% of your preretirementincome to maintain yourlifestyle after retirement. If your earningsare, say, $120,000 per year justbefore you retire, you will need $72,000in retirement income. If your income is$200,000, you'll need $160,000 peryear to retire in the style to which youhave become accustomed, according tothe most popular school of thought.

However, Walt Woerheide, PhD, vicepresident of academic affairs, theAmerican College, believes that mostpeople experience a significant drop inexpenses when they retire. "Chancesare your mortgage will be paid off,you'll no longer need to put asidemoney for savings, and your childrenwill be finished college."

Carl J. Kunhardt, CFP®, says hisexperience is different. "We're findingthat clients are spending essentially thesame in retirement as before. It's whatthey are spending on that changes inretirement."

Obviously, experts don't agree on asingle model for estimating financialneeds in retirement. More problematic,perhaps, is that some of the popular formulasfor estimating required retirementincome fail to consider inflation.That's why you must.

The Charles Schwab brokerage companyrecently published a retirementplanning rule-of-thumb that takes clearnotice of inflation's effects. It suggeststhat you will need $230,000 in retirementsavings in today's dollars to provide$1000 in monthly income duringretirement. If you want to add $5000per month to your Social Securityincome, you would need $1,150,000 inretirement savings and investments—intoday's dollars. The key phrase in theSchwab formula is "in today's dollars." If, for example, your retirement is 10years off, you must increase the$230,000 in the formula to allow forthe effects of 10 years of inflation.

Obviously, no one can predict theexact inflation rate in advance; all wecan do is estimate. Even assuming thattoday's inflation rate of about 2.5% willremain the same over the next 10 years,that $1,150,000 in today's dollars willbe about $1,472,096 in 2017 dollars.

How to Compensate

Financial consultant Ingrid K. Lamb,Chesapeake Beach, Maryland, pointsout that Social Security and some privatepensions are adjusted annually tohelp counteract the effects of inflation.However, retirees depending on investmentsfor a significant part of theirincome may find that's not enough."One way of compensating for inflation," she says, "is to invest part of yourportfolio in dividend-paying stocks witha long history of steady dividendincreases."

Maury Randall, professor of financeat Rider University, Lawrenceville, NewJersey, agrees that every retirement portfolioshould contain some stocks as ahedge against inflation. "Anothermethod of protecting yourself is aninvestment in Treasury inflation-protectedsecurities (TIPS). These Treasurybonds provide a return based on thecurrent rate of inflation," he says. "So,when inflation rises, you'll get a higherinterest rate." You can get more informationon TIPS from any broker or atTreasuryDirect, the US Treasury's Website,

Whatever form your personal retirementplan takes, make certain that youtake the inevitable effects of inflationinto account.

Beating Inflation's Effects

Use the following tips to help meet your retirement goals:

•Prepare a detailed and flexible plan for your retirement and keep it up-to-date asyour circumstances change.

•Maximize your contributions. Contribute as much as you can as early as you canto your tax-deferred retirement plan. Allow the magic of compound interest to helpcounter inflation's effects.

•Resist the temptation to use your retirement portfolio as an emergency fundingsource. Cashing out a portion of your tax-deferred retirement plan will result in taxesand penalties that will put a serious dent in future growth.

•Include some equities in your retirement portfolio. Most experts agree thatstocks historically offer the best opportunity to achieve a rate of return on investmentthat will outpace inflation.

•Invest in dividend-paying stocks that have a long payment history and a recordof steady dividend increases.

•Invest a portion of your retirement portfolio in Treasury inflation-protected securities(TIPS).