Personal Finance

The Simple Reason You Can't Know Your Retirement Number

Cpi Change

The idea of finding your "retirement number" -- the amount you need to save to live a comfortable retirement -- is very appealing to many Americans. And don't get me wrong: the idea behind the retirement number is good: It encourages people to plan and make a budget.

Unfortunately, particularly for someone far away from retirement, it's impossible to know exactly what your retirement number should be.

Cpi Change

Data source: BLS.gov. Chart created by author.

While I don't think anyone expects to see the 10%-plus inflation that we saw in the early '80s, the fact is that we are living in an era of almost unprecedentedly low inflation. Some reversion to the mean (perhaps 4% or even 5% annual inflation) doesn't seem unreasonable for at least a portion of the next three decades. And, of course, no one can predict the future, so it could be worse.

But let's accept the premise I shared for a minute: How much difference would a percentage point make in your retirement plans?

Quite a bit, as it turns out.

Let's say you need $1 million in today's purchasing power for a planned retirement 30 years from now. To achieve that level of purchasing power, you need to save a total of $1.8 million to account for a 2% inflation rate. At a 3% inflation rate, that number jumps to $2.4 million.

Here's what you can do

Don't stop reading just yet, because there are a couple of silver linings: First off, Social Security is indexed to a form of inflation ( the CPI-W ), so its purchasing power should stay relatively constant, assuming of course that benefits aren't reduced by budgetary constraints starting in 2034. The government has always stepped in to replenish the Social Security fund in the past, so I think concerns about the program reducing benefits are overblown.

Secondly, if you have 30 years until retirement, you have plenty of time to adjust your savings plans for different scenarios. If you built a retirement plan with the expectation that inflation would remain low, create another scenario in which inflation is significantly higher (perhaps 4%) and work the same math. If you're unsure where even to begin retirement planning, start here and get to work.

Retirement planning ultimately all comes down to two key things: Having a plan, and commiting to saving lots of money. If inflation looks like a daunting hill to summit, remember this: Large-cap stocks have historically returned 10% annually before accounting for inflation...and about 7% after. Time is your ally; use it to get the retirement you deserve.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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