The Power of Inflation to Erode Retirement Capital & Savings

Posted on September 20, 2011 by Bill Faiferlick

CPI, Inflation and the Amount of Capital Required for Funding Your Retirement: Are these indices understating your needs?

There are a number of financial forecasting programs available at the click of your mouse – input your income, your savings and within seconds, you have a figure for your future saving’s needs right. Well, perhaps! The critical factor in evaluating retirement needs is largely contingent on the income needed during retirement and the inflation factor used – inflation being the eroding value of earned income, savings and purchasing power.

CPI or the Consumer Price Index is released monthly from the Bureau of Labor Statistics reflecting a specific bundle of goods and services from across the country with weighting attributed to selected commodities totaling 100%. This percentage reflects price changes over time.  One notable issue is that the government can arbitrarily change the base year at any time.  Hence inflationary interpretations need to be viewed with some skepticism. The current base year is 1984, prior to that it was 1967. By assigning a new baseline year, (where all prices are effectively at current pricing), all previous percentage increases previously measured up to that point in time are eliminated and then start over. Consequently if we wanted to know what the cumulative inflationary rate has been without base line adjustments, we’d be hard pressed to find the data.

The government first started collecting data in 1913 and according to, the cumulative inflation rate since 1913 is 2,071%. The government has in affect manipulated this number to make it more palatable not only to US citizens but to the world at large.  Since inflation has risen 2,071%, something that cost a dollar in 1913 now costs $20.71. What I find shocking is that a dollar today is worth only 4.8 cents compared to a dollar in 1913. That’s the power of erosion through various money supply effects meaning since 1913, the government through its fiscal policies has devalued the dollar by more than 95.2 cents.

Money supply is largely a function of the Federal Reserve. The central bank which controls the money supply has the ultimate control over the rate of inflation. If the money supply is kept stable by the central bank, then price levels will stabilize. If the central bank increases the money supply rapidly, prices increase as the dollar’s value is undermined. The Federal Reserve, who oversees the nation’s money supply, has the authority to print dollars at will. Since August 2008, the Federal Reserve has expanded its balance sheet from about $900 billion to more than $2.2 trillion, creating $1.3 trillion that did not exist to replace some of the billions wiped out in the financial crisis.

Warren Buffet in an article on “How Inflation Swindles the Equity Investor” from a 1977 Forbes article said: “The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120 percent income tax, but doesn’t seem to notice that 6 percent inflation is the economic equivalent.”

This is serious since most people retire at age 65 need their capital to last for 30 years or longer. When using retirement calculators, the inflationary value entered can dramatically alter the amount of capital needed. Historically, a more accurate rate of inflation is closer to 9% not the rate of 3-4% commonly used. If you find this 9% unfathomable, consider the cost of transportation, fuel, food and heating as these consume a larger portion of everyone’s budgets. Historically, these expenditures have higher inflation rates associated with them than other goods. You can shift your buying habits from some commodities to other more affordable consumer goods, i.e. shopping at Wal-Mart but the composite of essential goods and services cannot be eliminated nor shopped as there are no alternatives. This leaves us more susceptible to their price fluctuations unlike other goods and services. Essential goods and services have a tendency to increase at a rate closer to double digits. The consumer experience on a limited income isn’t experiencing the 3% published inflation rate because the bundle of goods and services used (with higher inflationary rates) consumes a larger portion of their budget which means the family’s inflationary rate is substantially higher.

The government when calculating the statistical CPI may only consider that gas, heating, and energy accounts for 15% of the family budget, but as energy costs rise, a family may find that their total energy costs is closer to 30% or more of the budget yet the government has only weighted it as a small fractional percentage of the household budget which supports the argument that the real CPI we all are faced with is clearly pergent.

Consider that since last year, the price of corn is up around 65%, the price of eggs is up around 28% and the price of bananas is up around 21%. Here are two great examples using inflation calculators which demonstrate the incredible power of capital erosion:

What cost $1,000,000 in 1987 would cost $1,802,663.12 in 2007;

Going back further what cost $1,000,000 in 1977 would cost $3,384,973.74 in 2007.

When considering the most suitable options for securing your future and protecting your assets, the ongoing erosion of purchasing power due to inflation is crippling. By adding the additional tax burden, this combination must be aggressively accounted for in any long term planning opportunity.

Tax smart investing environments need to be given greater considered by most business owners, affluent inpiduals and professionals. Without real consideration to the tag team of inflation and taxes, your retirement plans will not live up to your planned expectations.

For Links to Inflation Calculators, try:

Bureau of Labor Statistics

The Inflation Calculator