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How does Inflation affect my Retirement?
Note: You can use any financial calculator to do this problem, but if you want the BEST, you can
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THE SCENARIO
I recently got a letter from the company that manages the 401(k) accounts at the place I used to work. They said that if their projections are correct, then when I retire (in 23 years), my account should provide $48,000 per year in income (amounts have been changed to protect the innocent). Wow, $4,000 per month to live on! Sounds great! (Actually, it sounds a little thin to me if that's all the income I have, but we'll go with it for now.)
However, I've heard of inflation, so what I want to know is 'How much buying power, in today's dollars, will that $4,000 per month have in 23 years?'
To keep things simple, I'll use monthly compounding, and an inflation rate of 3.7%. (This is about what the average annual inflation rate has been in the United States for the past 40 years.)
If you don't like my 3.7% number, feel free to use one you think better matches reality, or that better predicts the future. I got my figure
here. Keep in mind that if you decide to use a different inflation figure, your answer will turn out different than mine.
THE SOLUTION
First things first, make sure the calculator is using 12 Payments per Year.
23 years is 23 x 12 months, which is 276 months.
N: 276
I/YR: 3.7
PV: (this is what I'm trying to find)
PMT: 0
FV: 4000
When I plug in the numbers, I find that my monthly stipend beginning in 23 years has the same buying power as
$1,710.19 today.
If I was questioning my living comfort after retirement on $4,000 per month, I'm
seriously questioning it at less than half of that figure.
You may wonder 'why does the calculator return a negative number for PV?' (The calculator says that PV is -1,710.19.) The answer is that another way to consider this scenario is to ask yourself the question 'How much would I have to invest today at 3.7% to get me $4,000 in 23 years?' Since I'm going to
get $4,000 in the future, I need to
invest (i.e. pay out) some money today, so PV is represented as a negative number.
