Financial Education, Part 2

Inflation
A lot of people who retire these days have roughly $75,000.  The reason is because they were told forty years ago that they would need that much to retire.  So that’s what they saved.

Now, today, $75,000 is an absurdly low figure for retirement.  But somebody retiring forty years ago would have had a pretty comfortable retirement on that amount.  The reason why $75,000 was sufficient for retirement then but woefully insufficient today can be summed up in one word:  inflation.

The historical average rate of inflation is about 5%.  This means that prices tend to double about every fifteen years.  So in forty years, prices will double 2.5-3 times.  Call it 3 to make calculation easier.  The 1st doubling will take that $75,000 to $150,000.  The 2nd takes it to $300,000 and the 3rd takes it to $600,000.  So somebody who started their retirement planning forty years ago should have planned to save about $600,000 instead of $75,000.

In the same fashion, somebody who plans to retire thirty or forty years from now should try to save a lot more than the current retirement figure–say 2 or 3 million dollars.

Inflation and interest rates
You can’t simply throw some money into a CD, and expect to end up rich.  About the most you could reasonably expect would be for that money to grow as fast as inflation–and that’s if you choose the longest CDs.  To reliably keep ahead of inflation, you need a longer-term vehicle than CDs.  If you’ve got a high tolerance for risk and volatility, you can simply jump into the stock market and see what happens.  If you’re in the stock market for a long time, you’ll come out ahead, although there will definitely be some roller-coaster moments along the way.

Or–or in addition–you can put some money into an annuity.  Annuities pay higher interest rates than CDs, because they run longer.  Right now, even the longest CDs pay only about 2%.  But annuities are paying 4% or higher.  That may not sound like much, but it’s significantly higher than the current rate of inflation.

Over the medium term, say 7-10 years, an annuity offers safety and a guaranteed return.  Over that length of time, you may or may not make money in the stock market.

Advantage of time
Time is your greatest friend when saving for retirement.  Suppose you receive a $10,000 inheritance when you’re 30.  You find some investment, possibly an annuity, that allows your money to double every ten years.  That’s 7.2%, which is quite easy to achieve when you’re planning for the long term.  When you turn 70, your $10,000 will have grown to $160,000.

Small changes, such as eating out one time less a month, can help a person save money.  Say you save $5,000 over the course of three years.  That averages out to $4.57 per day.  Once you have the $5,000 saved up, you stick it in an annuity or a good mutual fund.  And you repeat that process for fifteen or eighteen years.  You’ll have a significant chunk of your retirement planning done.

These are some of the general ideas and principles that should be taken into account when planning for retirement.  Obviously, not everybody can do all these.  But anything is better than nothing.

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About lifeandhealthadvisor

I teach people about insurance and how money works, and I help people decide which form of safe money is best for them. I operate primarily in the Pikes Peak region.
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