Everybody’s financial situation — age, income, saving rate — is different.
But every retiree, early or late, aspiring or actual, has the same, simple investing imperative: We must preserve and grow our purchasing power in real terms in order to finance decades of future consumption.
This sounds simple (which it is) and obvious (which it isn’t).
The Declining Value of Your Dollars
Let's assume you're forty years old. Every week, you buy a six-pack of your favorite microbrew for $10. You have $520 in savings that will buy you your weekly six-pack for all of 2019. Life is good.
Here, for instance, is GRS founder J.D. Roth with a $10.19 six-pack of his favorite beer, which he's drinking while he edits this article:
Now, let's assume that the cost of this six-pack increases by 3% annually — which is a reasonable estimate of inflation. Every year, your $520 in savings buys you 3% less beer.
In thirty years, when you’re seventy and still enjoying your suds, that six-pack that costs you $10 now will cost you $24.27, which is a $1,262 annual expense if you continue to buy a six-pack a week.
In other words, your $520 in savings has to increases by nearly 145% to $1,262 over the next thir[s]ty years to merely maintain — let alone increase — your current beer consumption.
It gets worse.
Even if everything goes according to plan and your beer money grows from $520 in 2019 to $1,262 in 2049, you’ll need to sell $1,262 worth of your investments to get the cash for your beer. That will trigger a $750 taxable gain, and at a 25% federal and state tax, you'll have to pay approximately $188 in taxes. Your beer money is now approximately $1,074. This only buys you 44 six-packs of beer in 2049, whereas you were consuming 52 six-packs in 2019.
In other words, due to inflation and the taxation of nominal gains, you’ll be poorer, with a lower standard of living, thirty years from now.
This bears repeating: A 3% pre-tax return on your investments will not preserve, let alone grow, your current standard of living. [Read more…]