News reports constantly remind us that inflation affects the U.S. and world economies—it also has an impact closer to home. Inflation is defined as the average increase in prices of goods and services over time (typically measured annually). Some of the most common examples would be the rising costs of gas and food. When inflation goes up, your buying power goes down and your cost of living increases.
Of course, it’s important to understand how inflation affects you.
Why inflation matters
Many experts say you’ll need 70% to 90% of your current income to maintain your standard of living in retirement. But when you consider additional factors, such as inflation and rising healthcare costs, financial experts say that you may need as much as 126% of the amount you’re earning when you retire1. To see how much income is needed in retirement when inflation is factored in, use the Interactive Retirement PlannerSM
Use this Inflation Calculator from the U.S. Department of Labor to see how inflation has affected your buying power over the years.
Inflation vs. rate of return
If your investments don’t keep pace with the rate of inflation, you may lose purchasing power.
The difference between your investments’ total rate of return and the inflation rate is often called the real rate of return.
Here’s a simple example:
If you invested money at a 5% interest rate and inflation also rises by 5%, you’ll effectively not have earned anything. However, if the inflation for the year is only 2%, you’ll have made a profit of 3% on your investments.
Conversely, if your investments are earning 5% and inflation is, say, 7%, you’ll have lost 2%.
Keep in mind that investing involves market risk, including possible loss of the money you’ve invested. And there is no guarantee you will achieve your investment goals. This illustration is only an example. It is not meant to project the returns of any specific investment. If fees and expenses had been deducted, the returns would have been lower.
Get the help you need
Talk with one of our Education Consultants for more information about planning for your retirement.
1 Hewitt Study Reveals Widening Gap Between Retirement Needs and Employee Saving Behaviors, http://hr.cch.com/news/pension/072308.asp (accessed 6/15/11).