Inflation plays a crucial role in your retirement planning. Investors should anticipate 2% - 3% inflation each year, meaning that the costs of goods and services rise substantially over time.
Retirees should also consider that inflation is different for different items. For instance, health care has a higher rate of inflation each year than retail goods, and the cost of home improvements generally rises faster than the cost of food.
Since retirees spend a disproportionate amount of their money on health care and home improvements/home goods, they should plan for higher rates of inflation. For example, $100 of purchasing power today (let’s suppose you’re 30 years old and assume a 3% rate of inflation) will only be $30 when you’re 70.
Therefore, a retiree has to discount the growth of their retirement portfolios by a hypothetical inflation rate, to account for the decreasing spending power that each dollar will have over time. Most financial advisors can help retirees plan for the inflation effect, by running Monte Carlo Simulations that factor-in the effect of inflation over time.
How are My Retirement Benefits Computed?
Where do I Get Started in Saving for Retirement?