The GOOD OLD DAYS
Twenty-five years ago, a first-class stamp cost 22 cents and the average price of a new home sold in the U.S. was $100,800. First-class stamps now sell for twice as much and new homes cost $270,400 on average (in 2009).*
Year In, Year Out
The reason you have to dig deeper in your pocket to pay for things from one year to the next is inflation. In recent years, the inflation rate has been relatively modest (especially compared to the double-digit inflation rates of 1979 and 1980). But even a low rate of inflation will put a serious dent in your buying power over time.
Taming Inflation
Retirement investors need to be particularly conscious of the effect inflation can have over time. Fortunately, you can combat inflation's effect on the nest egg you're building. One approach is to choose investments that have the potential to provide inflation-beating returns. Historically, stocks have done that. The average annual total return of large company stocks (as represented by the S&P 500 index) for the past 25 years (1985-2009) was 10.54%. The average inflation rate for the same period was 2.91% (as measured by the Consumer Price Index).
History certainly can't predict future stock market returns or inflation rates. However, conventional wisdom suggests you'll have a better chance of beating inflation by including stock funds or portfolios in your retirement account than by holding only conservative investments.
Increasing the amount you're saving for retirement is another good strategy for offsetting inflation's effects. The sooner you begin setting extra money aside, the better.
Be Prepared
Some costs have been escalating faster than the "official" inflation rate for several years, most notably college costs and medical expenses. Health-care inflation in particular could have a detrimental effect on your retirement finances since more and more health-care costs are being passed on to retirees. Be sure to take medical expenses into consideration when you are estimating the income you'll need.
Into the Future
The 22-cent stamp has gone the way of penny candy. And one day, you'll probably look back and remember 2010 as a time when things were cheaper. But if you plan for inflation, you'll be ready for good days ahead.
* U.S. Census Bureau, www.census.gov
