The Inflation Myth

How Higher Costs Will Affect Your Retirement

You may have heard a common retirement myth that says if you have $1 million invested and it grows at a 5% rate, you can pull out $50,000 a year and be fine for the rest of your life.

Unfortunately, there are two problems. First, you’re setting yourself up for the worst taxable situation possible. Second, you need to consider inflation. If inflation is 3% and you’re withdrawing 5%, your portfolio has to make 8% just to keep up with your buying status.

At Mattson Financial, we aim to earn our clients 3% above their withdrawal rate. If a client starts with $1 million, a 3% return over 24 years will turn it into $2 million. It sounds great, but the reality is we’ve only kept up with inflation. What $1 million would have bought us today will cost $2 million 24 years from now. 

In 1974, my grandparents came to me on my graduation day and handed me keys to a brand-new Cadillac Eldorado convertible. It was white with a red interior. I went out to see my car, but I couldn’t find it. I went back inside, and all of the adults were snickering. I said, “Where’s the car?” They responded, “We got you the keys; you get to earn the car.” Cute to them at the time, not so much to me.

Back in 1974, that Cadillac was $4,373. Today, an average-priced car (not as fancy as the Eldorado) costs more than $43,000. Twenty-four years from now, vehicles will probably cost $80,000–$120,000. The question is this: Can you afford it? Whether it’s travel, going to restaurants, or just eating food you bought at the grocery store, everything will cost more.

Currently, inflation rates are over 7%. So, if you’re withdrawing 5% from your portfolio, it has to earn 12% to keep up. Once you add in fees, you’ll need 15%–20% returns, and no portfolio can sustain that type of risk. So, what is the answer?

To manage inflation, we first have to create a diversified portfolio. That means including investments that do well during inflationary times, like real estate or commodities. Some people are looking into cryptocurrency, but avoid overexposing yourself with speculative investments. Structured notes or treasury inflation-protected securities are other options. While these won’t make you rich, they will help your money keep pace with inflation.

Secondly, you want to limit your cash savings. Having an emergency fund for up to six months is a good idea. But with more than that, you’re losing out by only getting a .5%–.75% return. You want to invest those dollars elsewhere. With high-yield bonds or structured notes, you’ll receive better returns while still having access to money in an emergency. 

The key is to consider your increasing income needs. With all our clients, we project higher-income withdrawals later in life. We’ve talked many times about the three stages of retirement: go-go, slow-go, and no-go. Even in your no-go years, your 80s and 90s, you’ll need more money than you did in the go-go years. Older people have higher health expenses, and everyday expenditures like utilities and food keep rising. If your income is not increasing to meet that need, you will run out of money, look for ways to economize (like moving in with family), or end up on subsistence programs.

Usually, we don’t even notice inflation as it’s happening — only when we look at a gallon of milk that used to cost $4 and realize it’s suddenly $50. Recently, I had the privilege of taking my four grandchildren, two daughters, and wife to the movies. After paying for tickets, popcorn, pop, and a pizza or two, I was out $135. In 1972, if I had $20, I could watch two movies, buy two tanks of gas, and afford a dinner out with my friends. I guess I’m entering the old folks’ road where I say, “I can remember when $1 used to be worth $1.” 

Just remember, at Mattson Financial Services, we’re keeping an eye on your investments and returns to help you build wealth that takes inflationary times into account. That way, you can have this stress-free retirement you planned.

-Gary Mattson