Employing Reverse Inflation For Retirement Planning

One of the most interesting factors when it comes to personal finance for me is inflation. Inflation changes the buying power of currency over time. It changes the real value of debt and loans. And it changes the real value of assets.

Inflation Overview

The idea of inflation is somewhat simple. Over time, the amount of increased population, wealth accumulated, and debt created by the government for programs all represent more fake money. That is, money in the form of electronic debits and credits. More stocks are issued, more stuff is made, and more loans are created for more people. All of this currency is often tied to a real tangible item, gold, shells, jewels which are used as currency that is of itself, valuable.

However, at a certain point, there is more people or needs to have the valuable currency than there is actual currency to go around. So, instead of needing the currency, we just say a dollar is worth a dollar. And society/goverment puts all of the “real” or “tangible” currency some place safe and say that a dollar is worth a dollar of gold. But, with the the pressures of inflation, we need more dollars than we have gold. Plus gold becomes so valuable that people don’t want to use it as a currency for fear of losing it. I mean, can you imagine bringing diamonds or gold to school to buy school lunch?

To resolve the shortage, goverments print more money. And down the slippery slope we go. Now we have way more dollars than we have gold and that is not likely to change. And to keep the economy expanding, the goverment lends out money. But money is often electronic now, so the government doesn’t even need to print the money to lend it out. Instead it lends it in the form of zeros and ones to the financial institutions, all of which “pay the government” rent on that money.

Inflated Retirement Dreams

Getting back to retirement…the challenge of retirement is having enough money to live on once you get there. And assuming that you’ve done your homework, you should. But understanding how much you will have is not necessarily a good way to determine whether you will have enough money. Reviewing the guidelines are a great start, but much of the final call will be up to you; a gut feeling about whether or not you can really afford to stop working or if continuing a normal schedule really makes more sense. Or perhaps something in-between is really the best option.

Here are the common guidelines that are cited:
1. Expect to spend 80% of your work-day earnings when you retire. But how do you get that figure if you are not ready to retire this minute? Using inflation to your advantage is a good option. You can simply take the amount of money that you spend each month and adjust it by the compounding interest rate of 3% for enough years to get you to retirement. Then take 80% of that total.

2. Expect to take only 4% of your total projected retirement earnings per year. Find out your monthly income (before taxes usually) by taking the total amount and multiplying by 0.04 and then dividing by 12 to get the figure. Then reduce that figure by your tax rate if it is an non-roth or non-tax-exempt income.

An alternate calcuation would be to deflate your retirement earnings to today’s dollars. This puts things into more perspective. I find this works well for me because it is hard for me to imagine a gallon of milk costing 5 bucks.

A Deflated Calculation

Assuming that you have done some retirement calculations you should know what your monthly income will be. Once you figure that out, you can use a tool in your toolbox to easily determine how much money (in today’s dollars) you will have if you know how many years until retirement.

The Rule of 72

This is a common trick to estimate how quickly a particular interest rate will work to double your money for investing. But since math is all about contstants, this equation also works in reverse.

For example, say you have 30 years until retirement, but plan to retire with a 12000/month income. The rule of 72 allows you to divide your interest (or in this case inflation rate) by 72 to determine the amount of years. For a 3 percent interest rate, you are talking about 24 years until your money is cut in half. And 30 years divided by the 24 that it will take to cut your purchasing power in half shows a 1.25 ratio. Removing this amount from your total means that your real purchasing power is about 4500/month in todays dollars.