Chart of the Week for June 8, 2012 - June 14, 2012
In retirement, it is not only spending that affects the value of a retirement account -- inflation impacts it as well. Inflation is defined as a general rise in the prices of goods and services. So as inflation increases, the purchasing power of savings, such as retirement assets, decreases. In other words, savings will not buy as much.
For example, the above graph illustrates the effect of different levels of inflation on the purchasing power of a retirement account, assuming: no withdrawals, no contributions, no other earnings, and retirement at age 65. The first case (blue) assumes no inflation so the purchasing power of the fund is maintained at $100,000 over time. In the second case (gold), inflation is assumed at 2.5% per year, approximately the level of inflation over the past 20 years. In this case, the average amount of goods and services which could be purchased after 10 years, at age 75 is reduced by over 22% to $77,633 and by almost 40% after 20 years at age 85 to $60,269. And if the inflation rate were to rise to 5.0% per year (green), the average purchasing power of the fund would drop 40% in 10 years at age 75 and nearly two thirds (64%) after 20 years at age 85. And that is before any withdrawals for any types of expenses.
When setting financial goals for retirement, inflation is one of the factors that should be included in the considerations. If portfolio returns do not offset inflation, the purchasing power of the account will be reduced. Conversely, if the portfolio returns exceed inflation, the purchasing power of the account will grow. Depending on your risk tolerance, time horizon, and investing goals, each investor should balance risk and reward to create their own portfolio. Remember, the next 20 years may, or may not, look like the last 20 years.
© Copyright 2012 ICMA Retirement Corporation, All Rights Reserved. This information is intended for educational purposes only and is not to be construed as investment advice or a solicitation to buy or sell securities. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed here. Past performance is not necessarily indicative of future performance.
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