To reach retirement, almost everyone plans on working hard, saving money, and investing diligently so that they have enough money to coast into their golden years. Once they reach retirement, they will no longer need to work. However, it’s rarely that simple.
Saving for retirement via a retirement fund or savings account will only get you so far. The reason? Inflation. Inflation is a hidden tax in our economy that eats away at the purchasing power of your savings account every year. If you don’t pay attention to inflation then you will end up losing a ton of money during your retirement as the world around you grows more expensive.
Let’s take a detailed look at what inflation is and how it erodes your savings and retirement plan.
What is Inflation?
Investopedia defines inflation as a rise in prices which can be translated as the decline of purchasing power over time. Basically, this means the value of your dollar today will be worth less in the future.
As both a consumer and investor, you need to keep this in mind in order to stay ahead of inflation’s impact. To beat inflation, you either need to increase your income over your working career or invest in assets such as real estate. In particular, real estate has many benefits that allow it to serve as a hedge against inflation.
Over the past 30 years, inflation has averaged 2.3% annually. So if you need $70,000 of income to cover your expenses today you would need to earn about $102,000 in 20 years to maintain your way of life.
However, if inflation grows higher than 2-3% then its impact becomes much more severe. For example, take a look at this chart from annuity.org that highlights $100 of purchasing power over time during a period of 8.5% inflation.
Assuming 8.5% inflation, someone who retired on a fixed income at 60 would be drowning under their increased expenses by the time they were 80. 8.5% may sound like an extreme example. However, it’s pretty much our current reality.
How Inflation Hurts Your Savings
By reducing your purchasing power, inflation reduces the amount that you’re able to save after paying your expenses. Since inflation is always increasing, your expense will cost more each year leaving you with less money to invest or save. At the same time, it decreases the purchasing power of your nest egg with each passing year.
But what exactly causes inflation? According to the Harvard Business Review, there are three main factors that contribute to inflation:
- Supply shocks – When the supply of a crucial economic good, like oil, is disrupted then it can lead to inflation. For example, if a key oil field stops producing oil then it will lead to a surge in the price of energy. And, since energy is required to create most other goods, this surge in the price of energy will cause lots of different products to also increase in price.
- Money Supply – When the money supply is increased, it can lead to too much money chasing the same amount of goods. This can cause the prices of goods to increase across the board.
- Expectations – Even the public’s expectations of inflation can have a real-life impact. For example, if consumers expect higher prices then they might demand higher wages. To compensate for paying higher wages, business owners might raise prices which leads to an increase in the price of goods. This can create a dangerous inflationary spiral upward.
As you can see, there are a lot of different factors that can cause prices to increase. With this in mind, the ultimate goal of saving for retirement is to invest in a way that beats the rate of inflation. Now, let’s go over some strategies on how to do this.
Inflation and Retirement
One of the most important things to consider when saving for retirement is how much money you will need during retirement to live the life you want. And part of that calculation has to include inflation rates or your money will quickly diminish over time.
For example, if you put your money into a savings account or CD that earns 0.5% in interest over time then it’s unlikely that your savings will be able to keep up with the rate of inflation (which is typically 2-3%).
Instead, you need to plan for retirement with investment tools that can keep up with or even beat inflation, such as real estate.
What Should You Do?
And one of the most effective ways to save and invest for retirement is with real estate. Real estate investing is advantageous because it can help you earn a return, save on taxes, and beat inflation.
Here are the biggest benefits of investing in inflation:
- You can increase tenant rents over time, making your investment inflation-protected.
- While purchasing power decreases, mortgage payments typically remain steady
- Real estate typically appreciates in value over time
So when it comes to saving for retirement, real estate is a smart choice. As a real estate investor, the value of your property will likely rise over time while your mortgage payment stays the same. At the same time, you can charge higher rent in order to keep your cash flow in line with inflation.
Overall, real estate is a much safer retirement tool than simply saving. And, in high inflationary environments, money that stays on the sidelines is not rewarded. The people that excel the most during high inflationary periods are the people who invest their money into appreciating assets like real estate.
We hope that you’ve found this article on active vs passive investing to be valuable! We hope that it has given you a better idea of the different styles of investors and which one might be the best fit for you!
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Sachin Maskey is a physician, real estate investor, philanthropist, and entrepreneur. He has over 17 years of expertise in the medical industry as a family medicine specialist. Outside of medicine, he is the founder of the commercial real estate investment firm Avatar Equity as well as the Dhana Yoga Foundation. You can follow along with Sachin on Instagram, Facebook, and LinkedIn.
