You need to get a handle on inflation. A dollar today won’t buy as much tomorrow — that’s the simple truth. Remember the old stories? “Back in my day a toothbrush cost 5 cents!” or “Gas was 15 cents a gallon!” Those memories point to one thing: you must figure out how much buying power your retirement number will have in the future.
If you plan to retire now, a million dollars is what you expect. Retire in 2050 and that same million may only buy half as much. So if you’re thinking, “I’ll work for 20–30 more years and retire in 2050 — no big deal,” don’t forget about inflation.
Using the same million-dollar goal looks fine until you consider that many items will likely cost a lot more in 30 years. For example, college tuition could rise about 5% a year. Your jeans might get cheaper, but your kid’s freshman year could hit your wallet hard.
That’s the core issue when you apply the Time Value of Money to early retirement. Using a handy inflation tool, you can project what a dollar will buy decades from now.
This isn’t what you want to see when you’re 60, 70, or 80. Even with careful budgeting, it could take six figures for Jane’s family to keep their current lifestyle in 30 years.
Some of the rates in that projection felt odd to me, but an overall 2.57% inflation feels plausible — low enough to be comforting. Of course, inflation can spike like it did in 1979–1980 if policy gets shaky. And we can’t predict future innovations or shortages that change what we buy. Maybe travel becomes super cheap with high-speed rail, or healthcare reforms cut big medical bills. Maybe we start paying fair wages for clothing instead of relying on fast-fashion. Lots of unknowns.
Next, look at our savings. If you follow the common advice, the 4% rule should cover you into your 90s. Using Jane as an example: she plans on $50,000 a year and has saved 25 times that — $1.25 million. That stash allowed Jane and her husband to pay off their small house and avoid luxury car payments.
The big factors going forward are market returns, taxes, and investment fees. Let’s assume the market returns 8% a year, roughly the S&P 500’s historical average through 2018, and that fees are tiny thanks to Vanguard Admiral shares.
Note: we won’t subtract inflation from investment returns here because we already adjusted future spending for inflation. Don’t double-count it.
With those assumptions, the 4% rule appears to work. But that relies on three big hopes: inflation stays reasonable, the market performs, and no huge unexpected bills (medical, legal, or supporting grown children) appear.
Now try a tougher scenario. Crank inflation to 5% and throw in a couple of bad recessions. Use the last 30 years of S&P 500 returns to model downturns like the post-9/11 losses (-10%, -13%, -23%) and the Great Recession (-38%).
In that case the 4% rule starts to fail around 2040. By then Jane and her husband are in their 60s and should be heading into decades of retirement. They might have more than $3 million in nominal dollars, but the following years could see their savings run out. I ran the model with an average 9% S&P return based on the past 30 years; by age 90 they could be down to just over $300,000 — which might only cover a single CAT scan by then if costs keep rising.
This bleak scenario assumes 5% inflation never eases and that expenses don’t drop with age. It also leaves out Social Security, which would help keep them afloat.
Next I used OnTrajectory to run some simulations for Jane retiring at 45 with $1.25M and about $4,000 a month in expenses (roughly $50,000 a year). I left inflation at the service’s default of 3% and ran Monte Carlo tests.
The result? A 100% chance of not being broke by age 90. With a million-plus in the bank, you can likely live out your years without major fear. Still, having side income in your 40s–60s can add a safety cushion and keep you engaged so retirement doesn’t get boring.
I haven’t used OnTrajectory much since my first look at Tyson Koska’s tool, but it’s improved a lot — easier and more fun to use. Try it and see if it could replace your spreadsheet.
Update 8/15/22: See the latest post on inflation and how OnTrajectory can help you plan and adjust.
Life throws curveballs. Major medical bills can wreck the best plans. Still, if Jane and her family retire in their 40s, the odds are good they’ll be okay.
A few moves to reduce risk: invest in real estate for cash flow and tax benefits, and prioritize health — eat better, limit meat, and exercise daily. Those last two aren’t life limiters, just smart habits.
Don’t let inflation scare you out of planning. Master the variables, plan carefully, and keep learning — that’s how you protect your future.