First Person: Figuring Inflation Into Our Retirement Planning

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Even though my wife and I have decades until our retirement, it doesn't mean we're content to rest upon our laurels and just assume our current retirement planning will be sufficient to get us through the next 30 years. Something called "inflation" can come into play during this time and make our current plans obsolete well before we reach retirement age. Therefore, I've worked at figuring inflation into our retirement planning early on. This helps give us a better view of what real numbers we could be dealing with when the time comes.

Knowing our Personal Inflation Rate

The government has been quoting us an inflation rate of around 2 to 2.5 percent in 2012. However, this doesn't mean that this is what our family's inflation rate is. By gauging our expenses over time, I've been able to determine that our family's personal inflation rate tends to hover right around 3 to 3.5 percent; although lately it's been somewhat higher due to things like tax and health care cost increases. We're often able to minimize the times when our inflation rate goes up though by making cuts in other areas like housing and food to maintain our standard rate.

Knowing our personal inflation rate gives us a better idea of how the costs that we incur on a regular basis are rising as opposed to a more generic rate that may or may not match our personal spending habits and that is determined by the government.

Factoring our Personal Inflation Rate into our Long-term Planning

Knowing our personal inflation rate helps us better plan for the long term. This way, we can use this number to project 10, 20, even 30 years or longer into the future. While there is no exact way to predict how changes in the economy or our personal situation could affect our regular costs, we can at least get a general idea of what costs will look like down the road. By taking our current annual expense total, and using that number as a present value with which to project future value expense numbers based upon our personal inflation rate, we can get an idea of where our costs could end up when we're retirement age.

Gauging Inflation Against Investment Returns

We can also use our personal inflation rate to get an idea of how inflation is affecting or will affect our investments down the road. If our retirement funds are earning 6 percent a year, yet our personal inflation rate is at 3 percent, it's like our money is only really returning us 3 percent above inflation. This gives us a clearer, more exact picture of the power of our investments and can help us plan leading up to retirement for how much we actually need our money to return. This can also help us avoid overextending ourselves once in retirement by overestimating how much we think our money can actually do for us.

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