How Inflation Affects Your Financial Independence

April 8, 2021
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As you build your retirement plan and save for a financially independent future, there are so many different things to consider. You have to strategize how to invest and manage your wealth based on a variety of factors. One major issue that is often overlooked—or not fully understood—is inflation. What really is inflation and how will it affect your financial independence?

The History of Inflation

In some ways, inflation has always been a natural part of the economy. As the years go on, prices go up. It is no coincidence that inflation rates have gone up with the creation of central banks like the Federal Reserve that essentially controls inflation through key economic policies. On the surface, an average inflation rate of about 2.9% a year seems fairly insignificant—especially if anyone remembers back to the double-digit rates of the 1970s! However, if you go back deeper into American economic history (before the Fed), you will see median rates of less than .07%. Let’s put it this way. $15 in todays money is the equivalent of $1 back in 1926.

Inflation and Retirement Planning

Inflation is truly one of the worst enemies of retirement planning because what you earn now won’t be worth nearly as much when it comes time to spend it. If you have a $100,000 income and an average inflation rate over 15 years, your income would be worth approximately $64,000 by year 15 (a 35% loss).

Another concern for retirees is medical expenses. As you age, your medical expenses typically rise and inflation in the healthcare industry has risen more rapidly than just about any other category in the past 30 years.

How to Adjust Your Financial Plan for Inflation

We’re not trying to say that the sky is falling. Inflation is going to happen naturally. Consumer costs go up while your purchasing power goes down. You may get cost-of-living income raises each year to somewhat keep up with rising inflation, but what is happening to your retirement savings? Are you gaining enough through your investment plan to make up for the inflation between now and the time you retire? These are the key issues to address.

Inflation is part of our lives whether we like it or not. This is why you need to have a sound financial plan and strong wealth management strategies that will keep you on the road toward financial independence. Inflation should be considered as part of your plan, so you can make sure you put enough away while you can. Meanwhile, you need to manage your investments and retirement savings accounts wisely. If those are earning you 3% a year while inflation is going up 5% a year, you are technically losing money. Your retirement plan should account for anticipated inflation and your assets should be managed accordingly.

Going back to my earlier example of a dollar in 1900. It would only be worth a few pennies today in comparative value. However, if you invested that dollar wisely, it could be worth much more than a dollar now—thus making up for inflation and increasing your purchasing power over time.

It takes a lot of careful financial planning and wealth management strategy to achieve financial independence. Inflation is just one important factor to consider. For help with all your financial planning and retirement planning needs, contact Illumination Wealth today!