One of the biggest threats to my own retirement plan is the cumulative impact that future inflation rates will have. Readers whose retirement income is not cost-of-living-adjusted need to evaluate the impact that inflation and the declining value of the dollar will have on their income, and be prepared to supplement their income as necessary.
NEW! Try my new interactive calculator that will convert any prior year dollars to any later year right on your screen. Then come back to this post and look at the bigger picture.
Decreasing Purchasing Power of the U.S. Dollar: What's $10,000 in 1900 Worth Today?
The graph above (click to expand) shows that if a shopper were magically transported from the year 1900 to 2012, the $100 bill that he had in his wallet in 1900 would now be worth only $3.48! That is, $100 in 2012 would have the purchasing power that $3.48 had in 1900; $10,000 would be worth only $348 today. That's a 96.4% decrease in buying power. Our shopper would consider current dollars virtually worthless. (Note: the calculations in the post were made using the inflation calculator introduced earlier this month.)
The Cumulative Impact of Inflation on Retirement PlanningSince 1900, U.S inflation has averaged 3.0% per year. However, even at that moderate rate, the cumulative effect is
remarkable. The implications on retirees should be clear; even moderate rates of inflation have a large impact over long periods. For example, if inflation averages 3%/year, in 20 years (e.g., between age 65 and 85) the value of a $100 bill will be almost cut in half -- it will lose about 45% of its value. (See What Will $100 be Worth in 10-20 Years?)
If you live in retirement for more than 20 years, or inflation rates are higher than average, the impact is even more dramatic. During my mother's retirement, the dollar lost over 70% of its value. Her retirement lasted almost 30 years, and included the high-inflation 1970's and early 1980's. It's possible that you could have a similar experience -- especially if you're female.
Consider Inflation & the Future Value of the Dollar in Your Retirement PlanningOne of the biggest threats to my own retirement plan is the cumulative impact that future inflation rates will have. Readers whose retirement income is not COLA (cost-of-living-adjusted) income need to evaluate the impact that inflation and the declining value of a dollar will have on their income, and be prepared to supplement as necessary.
Frankly, I'm even concerned about Social Security and other pensions/annuities that do have COLAs. Promised pensions can be paid only if there is enough money available to pay them. In addition, COLA increases in some plans may not keep pace with the actual increases in your yearly expenses. For example, some increases are based upon the increase in so-called "core" inflation. Core inflation does not include food and energy; my inflation does....
100-Year History of Decline in Value of a Dollar -- Log Version
Here's another graph of the exact same data (click to expand), but I've changed the scale on the vertical axis from the "normal" (linear) way you'd see it to logarithmic. As I discuss in about log graphs, when you're graphing data over decades, or when there are large changes in values, using a log scale for the vertical axis presents a more accurate picture. These two graphs highlight the difference.
The Advantage of Using a Log-Scale AxisIn the top chart, the drop in purchasing power between 1915 and 1920 dominates the chart -- it was a drop of almost $40. The inflation of the 1970's, on the other hand, appears relatively benign -- the value of a dollar decreased by less than $10. But note that in the teens you were starting from of base of around $80; in the 70's, you were starting from a base of around $20.
In the second chart, however, those two drops are about the same magnitude because they're both about 50% drops. The distance (on the vertical scale) between the start and end of each period is about the same; the drop in the 70's is just not quite as sharp -- it's over an 8-year period rather than a 5-year period. I think this is a more meaningful representation of what we're trying to measure.
Just to beat a dead horse, consider this. If, God forbid, inflation had been 100% in 2011, purchasing power would have been reduced from about $3.60 in 2011 to $1.80 in 2012 -- a drop of only $1.80. On the first chart, since it measures changes in terms of dollars, you would hardly notice. On the other hand, in the second chart you would see a drop of about the same magnitude as the drop in the teens, but this time over a shorter period of time. That's a lot more representative of what we experience in the real world -- and why my long-term stock market price graphs all use a log scale for the vertical axis. (For more on this, see About Log Graphs).
Related PostsWhat Would $10,000 in 19xx be Equivalent to Today? an easy way to convert dollar amounts in the past to the approximate equivalent amount this year.
How Much Will $100 be Worth in 10-20 Years? converts current dollars to equivalent value 1-50 years in the future assuming inflation rates from 1-10%.
100 Years of Inflation Rate History Graph of yearly inflation rates, and discussion of the impact.
The Observations Inflation Calculator/Spreadsheet: will calculate inflation and the change in purchasing power between any two years in the past -- e.g., between 1970 and 1980. The source for the above graphs.
To see the historical impact of inflation on investments, see:
100 Years of Inflation-Adjusted Stock Market History, 10-Year Treasury Note Inflation-Adjusted Return History, 100 Years of Inflation-Adjusted Housing Prices.
For lists of other popular posts see the sidebar to the left. A link to the subject index is in the header at the top of the page.
Pre-1913: Robert Shiller "Irrational Exuberance" data
1913 forward: Consumer Price Index for All Urban Consumers: All Items (CPI-U) from the U.S. Department of Labor: Bureau of Labor Statistics.
Copyright © 2011. Last modified: 2/10/2013
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