Inflation

Explanation

Inflation is the rate at which the overall price level rises. When inflation is 3%, a basket of goods that cost $100 last year costs about $103 this year. Your dollars have not disappeared, but each one buys less.

Inflation compounds just like investment returns do, only working against you. Over a long retirement, even moderate inflation can double your living costs. That is why long-term plans focus on real returns (returns after inflation) rather than headline returns.

US inflation is most often measured by the Consumer Price Index (CPI). The Federal Reserve targets about 2% a year over time, but actual inflation has varied widely, from negative in parts of 2009 to roughly 9% in mid-2022. Your personal inflation rate may differ from the official one depending on what you spend money on, such as housing, health care or tuition.

In scenarios, you set an inflation assumption. The app grows your spending, contribution limits you choose to index, and other inflation-linked amounts by that rate, and lets you toggle between nominal dollars (the actual future numbers) and today’s dollars (buying power). Monte Carlo runs can also vary inflation from year to year.

Example

You spend $60,000 a year today and plan to retire in 25 years. At 3% inflation:

• Growth factor: 1.03^25 = 2.0938
• Spending needed in year 25: $60,000 × 2.0938 = $125,627 to maintain the same lifestyle.

Looked at the other way, $100,000 received 20 years from now, at 3% inflation, buys what $100,000 ÷ 1.03^20 = $100,000 ÷ 1.8061 = $55,368 buys today.

A rough rule: at 3% inflation, prices double about every 24 years (72 ÷ 3).