Don't Neglect Inflation in Your Retirement Planning - Retire by 40 (2024)

Last week, I was out and about running some errands and I stopped by a Chinese restaurant near our home to grab a take-out lunch. This place used to have the best lunch special in town because the food was good and they charged just $5.50. I guess I haven’t been there in a while because now the lunch special cost $13. Whoa, that’s not cheap anymore. That’s inflation for you. I have been retired for only 10 years and things already cost more than twice as much. I can’t imagine how much lunch will cost in 30 years. Inflation is one of my biggest worries about early retirement. We are doing well now, but can we afford lunch in 2050? Anyway, I went home and had leftovers instead of buying lunch. Home cook meals are much healthier than Chinese take-out so I saved money and improved my health. That’s what I tell myself, anyway. Don’t forget inflation in your retirement plan because it can be a big factor.

*Written in 2016. Updated in 2022. Inflation was so low in 2016. Now, everything is much more expensive. It’s crazy. Hopefully, it’ll drop back to a reasonable level soon.

Inflation is insidious

Inflation is a huge problem in retirement. Everyone wants to maintain the same comfortable lifestyle after they retire, but our money buys less and less every year. Inflation is an even bigger problem for early retirement because the time in retirement is longer. I could be retired for 50 years if I’m lucky. That’s a long time for inflation to blow up our budget.

As a personal finance blogger, I see inflation from 2 main sources.

1. The increase in the price of the things we buy. We can use the Consumer Price Index (CPI) to estimate the increase every year.
2. Another big source is inflation is lifestyle inflation. As we generate more income, we tend to spend more as well. Most working families struggle with this because our culture encourages spending. Also, there are more and more things to buy every year. 10 years ago, we didn’t need a smartphone or a tablet. Now, they are a necessity.

As a family, we are doing pretty well with lifestyle inflation and we kept our annual expenses at the same level for the past few years. We live a modest lifestyle and we are happy with this level of spending. I don’t think we have to worry too much about lifestyle inflation. This is one reason why it is good to track your expenses. You can compare the inflation rate of your annual expense to the CPI. If your annual expense routinely outpaced the CPI by over 3x, then you probably need to make some changes to your spending pattern. For us, I mainly worry about CPI and not lifestyle inflation*.

*Wow, the good old days of 2% inflation. In 2022, everyone is worry about inflation. There are so many problems and inflation is the result. It’s painful.

What is the CPI anyway?

(From the Bureau of Labor Statistics)

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The CPI represents all goods and services purchased for consumption by the reference population (U or W). BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups. Major groups and examples of categories in each are as follows:

• FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
• HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)
• APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)
• TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
• MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)
• RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);
• EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);
• OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

Inflation data from the BLS

Most of us didn’t worry about inflation when I first wrote this post in 2016. It seemed like I was the only one who cared how much lunch cost. It’s way different in 2022. Inflation increased tremendously over the last 2 years. The price of everything from gasoline to food went up so much. Here is the data from BLS.

In reflection, we had it good for many years. The price of eating out increases just a little bit every year. The last 2 years were different, though. These days, I don’t even want to go out to restaurants. A pizza cost well over $20. Lunch special at ethnic restaurants costs over $10. The only cheap places to eat out are fast food restaurants. And they are just too unhealthy for me.

The interactive chart at the BLS is pretty good. You can select which categories you want to see. Check it out here – interactive CPI chart.

Keep up with inflation

Currently, we are doing pretty well with our finances. Even with high inflation and the stock market decline, our net worth is above 53x our annual expense. This is a good improvement since 2016 when it was 40x. If there was no inflation, we’d be even better off. However, inflation is a fact of life. We need to keep increasing our net worth to make sure we don’t run out of money when we’re old. Right now it is not too difficult because Mrs. RB40 is still working. We are adding over $50,000 to our tax-advantaged accounts every year. The stock market is down, but it’s a good opportunity to buy more stocks and increase our passive income.

Our net worth is ugly this year, though. It is down about 18%. Couple that with high inflation and the pain becomes real. Also, Mrs. RB40 took a sabbatical this summer so our income is down a lot. That’s personal stagflation! Ouch. The question now is can we keep up with inflation after Mrs. RB40 retires for real?

Everyone should know that it is not enough to stash money in your savings accounts. The interest rate in a saving account has been lower than 1% for years. That won’t keep up with inflation. You’re losing money every year if it is just sitting in a saving account. You need to invest to beat inflation.

• Stocks – Stocks represent ownership of companies. Companies sell products and services and can adjust their price according to inflation. Particularly, I think dividend growth stocks are a great long-term investment. Some companies aim to increase their dividend every year. If your dividend income increases more than the CPI every year, you won’t have to worry about inflation much. Historically, stock investment outpaces inflation. However, 2022 is a terrible year for stocks. You just have to ignore volatility and keep investing.
• Rental properties – Rental properties adjust very well to inflation. As a landlord, I can increase the rent to reflect the inflation. The property tax and maintenance costs also increased, so rents can’t stay the same from year to year. I also like real estate crowdfunding. It is way easier to generate passive income from real estate and you benefit from the economy of scale. I plan to invest in at least one new project every year. Currently, we have over $120,000 invested with CrowdStreet. Check out CrowdStreeet if you’re interested in generating passive income from real estate.
• TIPS – The Treasury Inflation-Protected Securities provide protection against inflation. Their interest rate automatically adjusts to reflect inflation. We put $50,000 in I Bonds in the last 12 months. It’s a good way to keep up with inflation.
• A job – Wage growth increased tremendously over the last 2 years. That’s part of why inflation is so high. It’s a good way to keep up with inflation. This isn’t exactly an investment, but getting a job is a good option if things ever get desperate.

These investments kept up with inflation when it was moderate. However, 2022 is a different story. Investors haven’t been able to keep up with inflation because stocks are down. It should still work out in the long term, though. Keep investing and you will come out ahead when the market recovers. It’s a good time to buy more dividend stocks and increase your passive income. Hopefully, inflation will get back to a more reasonable level soon. The Fed is working on it, but we’ll probably see a big recession before things improve.

Don’t forget inflation

The bottom line is you have to take inflation into account when planning your retirement. Early retirement might look good now, but everything will be much more expensive in 30 years. It’s not enough to save, you have to invest your savings, too. The vast majority of our investments are in stock and real estate so I am pretty confident we can handle inflation.

One way to check if your retirement plan is on track is to use the Retirement Planner at Personal Capital. I set the inflation to 4% and we still have a very good shot at a successful retirement. You can also add various income events and future spending goals. For example, I allocated $12,000 per year for health care and $20,000 per year for travel in the future. You can read more details in my review – The Best Free Retirement Calculator. Or you can just sign up with Personal Capital and try it out yourself.

To wrap it up, eating lunch out seems so expensive now. Unfortunately, the days of cheap Chinese lunch specials are gone. I don’t even want to go to a restaurant anymore and I’ve only been retired for 10 years. Well, I enjoy going out with my wife. That’s worth it. However, I’d rather make lunch at home than buy anything. I’ll probably loosen up once the stock market recovers. It’s hard to spend money when our net worth decreases every month.

Are you worried about inflation? How are you planning to deal with inflation after retirement?

Common Creative image by Pictures of Money