Purchasing power, over the long term, is a critical concept to understand when selecting investments for your financial plan. Purchasing power is the ability to keep spending money as life gets more expensive. One day you will retire and you want to be able to have freedom and control of where you spend your time. How awesome does that sound? For instance, you may decide that you want to retire in fifteen years with $8,000 per month in income. You’re also contemplating the possibility of moving somewhere with a more affordable cost of living. The icing on the cake is that the place you are considering has less traffic and the most desirable weather you can imagine! Are you with me?
This is a great start! You have clearly pictured where you want to be and estimated your need of $8,000 per month to cover your essential and discretionary spending. For this example, I am going to discount income taxes and social security benefits for which you may be eligible. I want to illustrate an important point around using the goal of $8,000 per month.
Using $8,000 today, and assuming inflation (think rising costs over time) of 2.43 percent over fifteen years, means it will take exactly $11,468 a month to replicate the same purchasing power that $8,000 a month has today. Let that soak in for a minute. We know life will cost more tomorrow and in order to prepare we will need to select investments that offer a higher probability of keeping pace with, or exceeding, the rate of inflation. It’s a good exercise in thinking about where you are today, from a monthly income and numbers standpoint, and stretching that out into the future. Assuming life is static, and costs won’t increase, can create a flaw in your planning and progress towards retirement. It would also be a complete bummer if you planned around the need of $8,000 per month income only to arrive at retirement to discover that you need more. That’s why we’re here.
The costs of property taxes, your mobile phone bill, online subscriptions, and a nice dinner out doesn’t stop increasing when you retire. If you’re doubting this, I’ll pause and ask you to speak to the next retired person you can find about their thoughts on the matter. I’ll be here when you get back…..
I think we can all agree that life will cost more tomorrow than it does today, but those costs will also continue to rise throughout retirement. You and your spouse, significant other, are looking at what may be several decades where you will be required to stretch your capital. Knowing this, how might you select your investments? How might you design your plan? What risks need to be factored in?
We’ll cover more on this topic next time…