3 - Inflation _________
3 - INFLATION _____________________________________________________________
I_____________________________________________________________ NTRODUCTION
We all have experienced prices increasing for everything we buy. For example, in 1965 gasoline for my car cost under thirty cents per gallon: that’s seven cents per litre! Today, where I live we’re paying $1.20 per litre or 17 times as much for our gas! Calculated over the 48 years, that’s an average increase of 6.1% per year. If that rate of increase in price continues, in 10 years we'll be paying $2.17 per litre ($8.21 per US gallon). In 20 years, we’ll be paying $3.92 per litre ($14.84 per US gallon). When considering the effects of inflation on our buying power during retirement, keep in mind the government pensions that are available. If your pre-retirement income was $70,000, most number crunchers recommend you should be able to maintain your lifestyle on about $49,000 per year in retirement income. Government benefits will make up almost a third of that total. The rest – well, it's up to you.26 Take into consideration the government pensions available to you when calculating the amount you want to earn from your savings. 26
http://www.cbc.ca/news/background/retirement/enough.html (Sunday, 31 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 29
Inflation
Inflation destroys the buying power of our earnings and savings during our entire lifetime (career & retirement).
3 - Inflation _________
However, it’s possible costs for health care and social and recreational activities may go up; so, you might want to have a higher retirement income than indicated above. _____________________________________________________________
D EFINITION _____________________________________________________________ Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time. Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future.27 _____________________________________________________________
H ISTORY _____________________________________________________________ Let’s take a look at: • what inflation has been for the past fifty years, • how inflation has affected the buying power of our money, • whether our incomes are keeping up with inflation, 27 http://en.wikipedia.org/wiki/Inflation (Tuesday, 19 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 30
3 - Inflation _________
• how inflation will affect our retirement lifestyle, and • whether we can save enough money for the retirement lifestyle we would like to have.
Inflation
On this chart, showing the Consumer Price Index (CPI) for 1960 through 2012 in Canada, inflation has averaged 4.03%. 28 However, there have been years when inflation was 10 to 13 percent.
On the following chart, showing CPI for 1960 through 2012 in the United States, inflation has averaged 3.88%. 29 Again, there have been years when inflation was between 10% and 15%.
28
www.StatCan.gc.ca/tables-tableaux/sum-som/l01/cst01/econ46a-eng.htm (Tuesday, 19 March 2013) 29 www.TradingEconomics.com/United-States/inflation-cpi (Tuesday, 19 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 31
3 - Inflation _________
If inflation continues to average 4%, we will need to earn the amounts shown on the following chart 10 to 60 years from now to maintain today’s buying power of $5,000 per month.
Inflation Dotted line indicates $5,000. On the following bar chart, the highlighted numbers show us the amount of principle required to produce the monthly income shown at the top of the bar at an interest rate or return on investment of 8% (see Appendix A).
_____________________________________________________________
F UTURE PERSPECTIVE _____________________________________________________________ When considering the near future, perhaps we should consider an inflation rate that reflects the past 20 years. If we look at Canada’s for 1990 through 2012, inflation has averaged 2.14%.
_____________________________________________________________ Profitable Planning & Management Inc. Page 32
Inflation
3 - Inflation _________
In the United States for 1990 through 2012, inflation has averaged 2.70%.
_____________________________________________________________
Projections - $2,500 Per Month
_____________________________________________________________
If inflation is averaging 2% and we want to maintain the buying power of $2,500 per month today, we will need to earn the amounts shown on the following page 10 to 60 years from now.
_____________________________________________________________ Profitable Planning & Management Inc. Page 33
3 - Inflation _________
Inflation
Dotted line indicates $2,500. The highlighted numbers on the following chart show the amount of principle required to produce the monthly income shown at the top of the bar at an interest rate or return on investment of 8%. For example, in 20 years we would need $557,100 in an account earning 8% (see Appendix A) to produce $3,714 per month to equal the buying power of $2,500 per month today. Will any of us have $557,100 or $828,000 in savings 20 or 40 years from now?
Dotted line indicates $2,500 If the interest rate or ROI were 4% instead of 8%, the highlighted numbers would be doubled. For example, in 20 years we would need $1,114,200 in an account earning 4% to produce $3,714 per month to equal the buying power of $2,500 per month today.
_____________________________________________________________ Profitable Planning & Management Inc. Page 34
Dotted line indicates $2,500. At 2% interest or ROI, the highlighted numbers would be doubled again. If inflation were greater than 2%, all the numbers indicated on the above charts would be even higher. _____________________________________________________________
Projections - $5,000 Per Month
_____________________________________________________________
If inflation is averaging 2% and we want to maintain the buying power of $5,000 per month today, we will need to earn the amounts shown below 10 to 60 years from now.
Dotted line indicates $5,000. The highlighted numbers on the following chart show the amount of principle required to produce the monthly income shown at the top of the bar at an interest rate or return on investment of 8%. _____________________________________________________________ Profitable Planning & Management Inc. Page 35
Inflation
3 - Inflation _________
3 - Inflation _________
For example, in 20 years we would need $1,114,500 in an account earning 8% (see Appendix A) to produce $7,430 per month to equal the buying power of $5,000 per month today. Will any of us have $1,114,500 or $1,656,000 in savings 20 or 40 years from now?
Inflation Dotted line indicates $5,000. If the interest rate or ROI were 4% instead of 8%, the highlighted numbers double.
Dotted line indicates $5,000. At 2% interest or ROI, the highlighted numbers would be doubled again.If inflation were greater than 2%, all the numbers indicated on the above charts would be even higher.
_____________________________________________________________ Profitable Planning & Management Inc. Page 36
3 - Inflation _________ _____________________________________________________________
Projections - $10,000 Per Month
_____________________________________________________________
Inflation
If inflation is averaging 2% and we want to maintain the buying power of $10,000 per month today, we will need to earn the amounts shown below 10 to 60 years from now.
Dotted line indicates $10,000. The highlighted numbers on the following bar chart show us the amount of principle required to produce the monthly income shown above each bar at an interest rate or return on investment of eight percent. For example, in 20 years we would need $2,229,000 in an account earning 8% 30 to produce $14,860 per month to equal the buying power of $10,000 per month today.
Dotted line indicates $10,000.
30 See Appendix A _____________________________________________________________ Profitable Planning & Management Inc. Page 37
3 - Inflation _________
If the interest rate or ROI were 4%, the highlighted numbers double as shown below.
Inflation Dotted line indicates $10,000. At 2% interest or ROI, the highlighted numbers would be doubled again. If inflation were greater than 2%, all the numbers indicated on the above charts would be even higher. _____________________________________________________________
L IFE EXPECTANCY _____________________________________________________________ Life expectancy is the expected (in the statistical sense) number of years of life remaining at a given age. It is denoted by which means the average number of subsequent years of life for someone now aged , according to a particular mortality experience. Because life expectancy is an average, a particular person may well die many years before or many years after their "expected" survival. 31 How many years should we plan to be retired? We often hear advice to set aside money for 30 years of retirement. Is that a reasonable time frame? 31 http://en.wikipedia.org/wiki/Life_expectancy (Monday 19 September 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 38
3 - Inflation _________
Inflation
According to the chart below, life expectancy at birth is 82.59 years in Japan, 81.85 in Australia, 80.93 in Canada and 78.64 in United States of America.32
As we progress through the years, our life expectancy increases. By the time we’ve reached age 65, Canadians can expect to live to age 83.5 for men and 86.6 for women. 33
Life expectancy numbers work on averages; since many men will die before reaching age 83.5 and many women before age 86.6, many others will live into their 90s. So, being retired for 30 years after age 65 is not unreasonable. Canadians who have lived a century are the fastest-growing segment of the population. The 2011 census counted 5,800 32
http://www.google.ca/publicdata/explore? ds=d5bncppjof8f9_&ctype=l&met_y=sp_dyn_le00_in (Monday 19 September 2013) 33 http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/health72aeng.htm (Monday 19 September 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 39
3 - Inflation _________
centenarians, a number that is on track to grow to 78,300 in 2061. That is enough hundred-year-olds to match the population of Sault Ste. Marie.34 We should be financially prepared to be retired into our 90s. It would be a big mistake to not consider inflation from now to our 90s. It would be a shame to run out of money before we die. Many people are already concerned about outliving their savings. Inflation
In a poll conducted late 2012, more than 3,000 Canadians were asked the question, “Do you think there is a serious risk you could outlive your retirement savings?” 38% admitted there is serious risk and 27% aren’t sure. Only 35% were confident they had enough savings to last their lifetime.35
Only 1 out of 3 Canadians is confident they have enough money saved to cover their retirement years!
34
Jim Leech & Jacquie McNish, The Third Rail (Toronto: McClelland & Stewart, 2013), 20 35 http://cdn.sunlife.com/static/canada/sunlifeca/About%20us/Canadian %20Unretirement%20Index/ 2013_Sun_Life_Canadian_Unretirement_Index_Report_en.pdf (Thursday 29 August 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 40
3 - Inflation _________ _____________________________________________________________
S UMMARY _____________________________________________________________
How are you doing? Will your income keep up with inflation? Do you see yourself earning the numbers indicated 20 or 30 years from now? Will you be able to save enough money to cover your retirement years? Do you have a plan to ensure you will have enough money to continue with your current standard of living?
If inflation continues to soar, you’re going to have to work like a dog just to live like one. – George Gobel
_____________________________________________________________ Profitable Planning & Management Inc. Page 41
Inflation
We’ve looked at inflation from a historical perspective and seen how it affects prices and the buying power of our money. We’ve also looked at whether our income will keep up with inflation and how inflation can affect our plans for our retirement years.