Protect Your Purchasing Power

Protect Your Purchasing Power

Have you ever stopped to think about why you invest your hard-earned money and put up with volatility every day? 

Seriously…why do you do it?

The answer to that ties into the next step in The Relaxing Retirement Formula™.

While getting back to the Fundamentals over the last few weeks, we’ve outlined the first few steps and you’ve gotten crystal clear on just how dependent you are on your Retirement Bucket™ today.

If you’ve come this far, and you’ve diligently discovered this critical number for yourself, you’re in an exclusive minority because the overwhelming majority of Americans are too unfocused and lazy to perform this vital task.

However, as much as I’d like to applaud your actions up until now, there’s a key missing factor to your number. 

That missing factor is what your level of Retirement Bucket Dependence will be next year!

In 5 years?

In 10 years?

In 20 years?

Why?

Inflation!!

Many so-called financial “experts” have been lulled to sleep over the years with inflation’s enormous negative long-term impact.  I continue to read articles and see websites of large financial institutions suggesting that you use 2% as an inflation rate in your forecasting.

This has been a big pet peeve of mine for years as I believe it’s a grave mistake to assume that the low inflation rates we’ve experienced over the last 20 years will continue forever.  That would be like assuming that the double-digit inflation we experienced from 1979 to 1982 would continue forever. 

Why Do We All Invest in the First Place?

Investing is often described as the process of laying out money now with the expectation of receiving more money in the future. 

I believe legendary investor Warren Buffet has a better take.  He defines investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.  More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.”

Take a moment to go back and read that paragraph again.  It’s THAT important of a distinction.

If you stop and think about what investing is, and why we invest, one of the major reasons is INFLATION.

We invest our carefully earned savings in order to have funds available for “future” expenses, i.e. college for our children, retirement when we no longer have the desire or good health to work to support our desired lifestyle, etc.

What we choose to invest in, however, is largely driven by the historical fact that prices on everything we consume rise over time.

As I recently revealed in another post, even if inflation only rises by the Federal Reserve’s target rate of 2% per year, your $10,000 per month lifestyle today will require $14,568 per month in year 20 to pay for the exact same lifestyle!  If it’s more like the long-term historical average of 3% per year, it would require $17,535 per month!

Purchasing Power

So, at its core, investing is about owning carefully selected assets that you believe will be able to help you maintain your purchasing power (i.e. keep pace with rising costs).

If you simply set money aside in your mattress, that would be better than not saving at all because, at the very least, you’d have the money later. 

However, it wouldn’t be worth enough to pay for what it is that you set the money aside for because prices continued to rise while your money remained under the mattress.

This simple principle is why it’s so critically important to establish investing principles and guidelines for yourself. 

The reason you invest, and why you’re investing in what you’ve chosen, will remain clear in your mind so you maintain investment discipline in ever-changing markets like what we’re experiencing right now.

Cost of Living Adjustments (COLA) on Income

With that clarification on inflation and its detrimental effect on your Relaxing Retirement fresh in our minds, let’s get back to your 3 potential fixed income sources that we evaluated last week and see how they stand up to inflation:

  • Social Security has a cost of living factor (COLA) built in, so, in theory, it keeps pace with inflation.  If your benefit is $2,500 per month right now, it will likely be approximately $3,200 per month in 10 years. (For scorekeeping purposes, you received a 1.30% COLA increase in January 2021)
  • Most pensions do not have a cost of living adjustment.  So, if your monthly pension is $5,000 per month, your check in 10 years will still be $5,000 per month while the price of everything has gone up!
  • Rental property income should, in theory, keep pace with inflation.  However, local rental market forces, and most people’s lack of tenacity in “raising the rent” each year, may have an impact on what income increases you can count on in the future.  Be careful and conservative with what you expect.

Now that you know all of this, take a look out at what your fixed income sources will look like, not just today, but in 10 years, 20 years, and 30 years. 

Create your own personal timeline.

How does your fixed income match up with your desired lifestyle costs that you’ve calculated?

Is there a deficit right now?  How about in 10 years (due to inflation)?

If there is, don’t sweat just yet.  That’s why you’ve saved all of that money all your life…to supplement your fixed income and fill in the gaps when you stop working.

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