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.

In 1965:
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

Today (2011)
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:

Year Inflation   Year Inflation
2010 2.00%   2000 3.20%
2009 1.00%   1999 2.20%
2008 2.00%   1998 1.20%
2007 2.50%   1997 0.90%
2006 1.40%   1996 1.90%
2005 2.00%   1995 2.10%
2004 2.40%   1994 0.00%
2003 1.60%   1993 1.90%
2002 4.40%   1992 1.70%
2001 0.60%   1991 4.10%

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?


  1. Bill Birnbaum

    I should think that inflation, over the next couple of years, will be relatively low — two percent perhaps. But all of the money being printed will catch up with us in a few years. When it does, I belive that inflation will spike up above four percent. Perhaps more. Bill

  2. cashflowmantra

    I would be using a larger number than 2% inflation. The measured CPI and reality don’t always seem to correspond at least not here in the United States as I watch gas and food prices. Core CPI (without food or gas) is only useful if you are a corpse.

    • Bill Birnbaum

      For quite some time, I had been thinking that we would see larger inflation numbers — four to five percent perhaps. I thought that much of the higher inflation would come from emerging nations’ demand for commodities, including and especially, oil. However, global growth, including that of the emerging nations seems to have slowed. So it looks like inflation will be moderate. Bill

  3. Claude Nougat

    Excellent advice, very clear for those who aren’t economists (I should know, I’m an economist – Columbia U. graduate). The principle you propose (use of CPI) makes sense. Obviously, it varies from country to country and the general trend is what you want to look for when you do your planning for retirement!

    This said, I believe you should also look at spikes and how often they occur (the volatility), and how large they are when they do occur: they are a good indicator of the stability of prices, and perhaps as a retiree, one should veer to the conservative side: for example, if the general trend is 2% (like in Canada) but there are some spikes up to 4% and more, you might want to pick 2.5% as your referral inflation rate and plan around that!

    Anyhow, good post, many thanks!

  4. Paul Viau

    Not only does inflation take a bite out of retirement , but it takes a bite out of what home
    the typical 55-65 yr old buys!

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