Why We Invest
Over the last few weeks, we’ve outlined the first few steps in The Relaxing Retirement Formula™ and you’ve gotten crystal clear on just how dependent you are on your Retirement Bucket™ today.
If you’ve come this far, and you’ve diligently discovered this critical number for yourself, I sincerely applaud you.
You’re in the minority already!
However, there’s a key missing factor to your number. And, that is what will your level of Retirement Bucket Dependence be next year?
In 5 years?
In 10 years?
In 20 years?
Many so-called financial “experts” have been lulled to sleep over the years with inflation’s enormous negative long-term impact. I continue to read articles and see websites of large financial institutions suggesting that you use 2.5% to 3% as an inflation rate in your forecasting.
This has been a big pet peeve of mine as I believe it’s a grave mistake to assume that the low inflation rates we’ve experienced over the last 20 years will continue forever. That would be like assuming that the double digit inflation we experienced from 1979 to 1982 would continue forever.
If you take a real objective view of what has transpired over the last few years on a national level with the enormous level of federal debt financing going on, it would be difficult not to conclude that higher inflation is going to enter into our picture.
Why We Invest
If you stop and think about what investing is, and why we invest, one of the major reasons is INFLATION.
We invest our carefully earned savings in order to have funds available for ‘future’ expenses, i.e. college for our children, retirement when we no longer have a desire to work, etc.
What we choose to invest in, however, is largely driven by the historical fact that prices on everything we consume rise over time.
Sending a first class envelope in the mail in 1980 cost 15 cents. Today, 34 years later, sending that same envelope in the mail costs 49 cents.
So, at its core, investing is about owning carefully selected assets that you believe will be able to help you maintain your purchasing power (i.e. keep pace with rising costs).
If you simply set money aside in your mattress, that would be better than not saving at all because, at the very least, you’d have the money later.
However, it wouldn’t be worth enough to pay for what it is that you set the money aside for because prices continued to rise while your money remained under the mattress.
This simple principle is why it’s so critically important to establish investing principles and guidelines for yourself.
The reason you invest, and why you’re investing in what you’ve chosen, will remain clear in your mind so you maintain investment discipline in ever-changing markets.
Cost of Living Adjustments on Income
With that clarification on inflation and its detrimental effect on your Relaxing Retirement fresh in our minds, let’s get back to your 3 potential fixed income sources that we evaluated last week and see how they stand up to inflation:
- Social Security has a cost of living factor (COLA) built in, so, in theory, it keeps pace with inflation. If your benefit is $1,300 per month right now, it will likely be approximately $1,750 per month in 10 years. (In 2014, you’re receiving a 1.5% COLA increase)
- Most pensions do not have a cost of living adjustment. So, if your monthly pension is $3,000 per month, your check in 10 years will still be $3,000 per month while the price of everything has gone up!
- Rental property income should, in theory, keep pace with inflation. However, local rental market forces, and most people’s lack of tenacity in “raising the rent” each year, may have an impact on what income increases you can count on in the future. Be careful and conservative with what you expect.
Now that you know all of this, take a look out at what your fixed income sources will look like, not just today, but in 10 years, 20 years, and 30 years. Create your own personal timeline.
How does it match up with your desired lifestyle costs that you’ve calculated?
Is there a deficit right now? How about in 10 years (due to inflation)?
If there is, don’t sweat just yet. That’s why you’ve saved all of that money all your life…to supplement your fixed income and fill in the gaps when you stop working.
Next week we’re going to move on to the next step in the Relaxing Retirement Formula™ which is to explore the most important question you need to answer now that you’ve done this all important groundwork.
It will completely change and simplify the way you view investing for the rest of your life.