Do you ever feel old when you remind yourself that something you bought, many years ago, is now a lot more expensive today? I’m going to give you a couple of examples from my own life. The first one is from when I was really small. I remember in our really small town we would ride our bikes to a small grocery store. I could buy a piece of gum for three cents or five cents. This was just an individual piece of bubble gum. Today, I don’t think you can even buy them in a store individually. If you can, it’s around 25 cents.
The cost of then versus now has obviously increased.
Another example is when I started driving. I remember it was a big deal when gas was going over a dollar. One day it would be 90 cents and the next it was a dollar. Fast forward to gas prices today. The $1.50-$2, $3, $4, depending on what year you’re choosing– that’s normal.
Inflation Affects Savings
I want to explain a concept called inflation, or cost of living adjustments. Inflation is something we watch closely and have written about many other times. The cost of something in the future will likely go up. This may not affect every single thing that you buy, however at somewhere in your budget, or somewhere in your expenses, you’re going to notice that expenses are increasing.
We need to factor this in to our savings plan. When we are creating a financial plan, we want to factor the cost of everything that you’re spending today, will go up in the future.
Inflation Savings Example
So I’m just going to use a rate that we see today–2 percent of inflation. And what I’m going to show you is at different dollar amounts, what this adds up to over the years.
This isn’t meant to scare you, but it is meant to show you that sometimes we think about wisely,
As an example of how savings without the cost of inflation could hurt you: If you spend $50,000 today. And in 20 years when you’re retired you saved for $50,000 times 20 years, you’d be completely ignoring inflation and the cost of those expenses going higher.
Here is the inflation of one dollar over the course of years. In this column, we have $50,000. And in this one, a $100,000. And so what I want to show you is that in the first year, today, I have a dollar. In one year, the cost of that dollar increases by 2 percent. So now next year, it costs me a dollar in 2 cents to get that same thing. Or if I spent fifty now, it cost me $51,000 to spend that same amount of money. So you can see how 100 and 102.
When we see the dollar and we say “That’s great it goes up by 2 percent”, a dollar becomes a $1.81. That doesn’t really impact us much. But now when we fast forward and we say “OK, but 10 years out because we spend more than a dollar, we’re spending 50 or 100, now that really starts to add up”. So this row right here, you can see 10 years out. You can see that a dollar, is now a $1.22. Or now it’s $60,000 instead of fifty. One hundred and twenty, instead of one hundred.
So now we start to see this actually does add up.
Now you can see 20 years out and 30 years out. Now this is important because some of us may say, “I’m starting now and I may work for another 20 or 30 years. And then I’m going to be retired for 20 or 30 years after that. At least that’s what is in my plan.”
Once you get past 20 years, things really start adding up. We’re not only stopping at 30 years, but there’s more beyond this. Once you get past 40 plus years you can see that the original amount has doubled!
This is a really important factor. Inflation is a big term that’s talked about regularly in the news and now you especially know why it’s important for your retirement. It affects your cost of living adjustments.
Making Inflation Savings Adjustments Today
Now you may be a person that says, “You know what this doesn’t really affect me. If I spend $50,000 today, you know I can make adjustments in my budget. I can spend less. So I’m always spending 50, whatever year that is.”
Let me just point out some additional examples.
For food, gas, and clothing – you may have bought this over the years and you will see a gradual increase. Consider where this would affect you? How much do you really need to be thinking about this?
But if none of those affected you, what about health care costs? We don’t know what we’re this is going to be in the future. And so if nothing else, we’re planning for the potential for some of these to increase. Even if we’re really focused to keep them the same.
I hope this is helpful to understand a concept like inflation, or cost of living adjustments. This is suppose to support you so that you’re mindful when you’re planning and not forgetting about this important piece that will affect you in the future.
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