Retirement has plenty of perks, but knowing exactly when those golden years will come to an end is not among them. That’s a snag for planning, and it underscores how critical—although typically nonintuitive—it is for you to work toward growing your assets even after you start pulling funds out.
"If your assets aren’t at least keeping pace with inflation, you will likely find your buying power shrinking over time as the cost of living rises,” says Sarah Newcomb, behavioral economist at Morningstar. “Your 90-year-old self will thank you for facing this reality now."
People are living longer—we all know that. You could well be one of those who spends more years in retirement than in your working life. And don’t put any bets on the cost of living going anywhere but up. You’re going to need to make sure your money continues to grow.
Inflation may be low now, but that’s a historical outlier. Over time, it shows a sure but steady rate of increase. "In the last 100 years, inflation has ranged from negative 18% in July of 1918 to almost 24% in June of 1920,” Newcomb says. Remember the double-digit inflation rates that ravaged the economy from 1979 to 1981? “The rate of inflation is volatile, but the average is around 3% per year. This means that, on average, things cost 3% more every year," Newcomb says.
Newcomb points to a simple mathematical principle called the Rule of 72 that helps estimate how long it may take for prices to double. Just divide 72 by the rate of growth, and you get the number of years before inflation doubles. For example, at 3% inflation, it will take a mere 24 years for inflation to double.
“Here’s where things can get really unpleasant,” Newcomb says. “Not only will the cost of living roughly double in 25 years, but it will double again after 50 years. That means a lifestyle that costs $75,000 a year today will cost $300,000 a year 50 years from now. The very same lifestyle—just way, way more expensive."
Fifty years may seem a long while off, but time has a way of not stopping. Economists call this consistent increase in the price of goods and services the time value of money (TVM). "Even when we know that prices rise, we tend to underestimate the impact,” Newcomb notes. “We need to be clear about how our lifestyle goals in retirement will translate into actual costs, and take the time to calculate what the cost of living might be in the future.”
Now, just because you need to keep your money growing doesn’t mean you need to take on a lot of risk. ”Once you’ve built up your assets to the point where they are producing a comfortable income stream, with inflation. That means an average growth rate of 3% per year,” Newcomb says.
And remember: The natural tendency to avoid this topic doesn’t magically make it go away. "Thinking through the details of your hopes and dreams for your retirement years, your goals for the legacy you hope to leave, and your family’s health history and life expectancy may make for an emotional challenge, but this is what your financial advisor is there for,” Newcomb says. “Investing one afternoon facing the uncomfortable truths of old age, death, and inflation might pay off in years of relaxed, joyful time in your golden years." That’s time well spent.