Inflation and retirement planning
Back in 1965 if you have $140,000 in the bank you would have been a millionaire by today’s standards. From 1965 to 2011, the average annual inflation rate was 4.39%.
Let’s face it, the purchasing power of $1 thirty years ago is different that today. I remember as a kid, my sister and I could go into a store with one dollar and get 2 chocolate bars, a bag of chips and a handful of double bubble. Today, if I took two of my kids into the store I could barely get out with just a five dollar bill for those same items.
a loaf of bread cost you 27 cents
a litre of milk was 31 cents
gas for your car was about 10 cents per litre
The average car was 2500
and my dad bought our starter home for a little over $10,000
that same loaf of bread is about $2.50
a litre of milk is $2.60
gas for your car is about $1.06 cents per litre
The average new car is over $30,000
and to buy an average home in Alberta is about $350,000 (inflation of real estate for other provinces)
Predicting inflation is like predicting the stock market or interest rates or housing prices but one thing I know for sure is the cost of living will increase so when it comes to financial planning and retirement planning it is so important to factor inflation into the picture. If you don’t you will not be accounting for the changes in the value of money because of the rising goods. If you think $1 million is enough to retire by today’s standards, that $1 million will not be worth the same 10, 20 or 30 years from now.
How do they measure inflation?
Inflation is measured using the consumer price index. The consumer price index is essentially the weighted average of a basket of goods that is supposed to reflect the average cost of living.
CPI is not perfect as it strips out some volatile items like energy prices but like it or not, it is the benchmark for measuring inlfation. CPI is used to change financial data and programs like pensions, CPP, and income tax.
What inflation rate should you use for planning?
Recently I wrote an article on what rate of return you should assume for retirement planning. Just like it’s difficult to know what rate of return to use, it’s also hard to know what inflation rate to use. That being said, inflation data is much more consistent than stock market data. Let’s look at some inflation data for the past 20 years:
source: Canadian Total CPI, Morningstar Paltrak 2011
In fact, if you look at inflation since 1990, it’s had a few spikes above 3% but for the most part, inflation has been consistently averaging less than 2%. lnflation is monitored closely and monetary policy is used to keep inflation at desired levels.
Typically, I like to use a 2% inflation figure for retirement plans. You can start with this benchmark and then adjust for your personal beliefs. For those people that think inflation is a real fear in the future, then increase that to 3%.
What do you think people should use as an inflation rate for retirement projections?