For financial advisors tasked with guiding their clients through financial independence, inflation is public enemy number one. Much like ocean waves relentlessly pounding the beachside cliffs, so is the silent but constant pressure on prices as the cost of living rises over time. Sometimes it will be decades before the impacts of inflation are felt, while other times inflation is headline news as gas prices soar, or the cost of your holiday meal skyrockets. But what is inflation and why is it so important to financial planning?
Inflation is defined as the decline of purchasing power of a currency over time. It is erosion… but of your purchasing power instead of the shoreline. This is incredibly important to clients seeking financial independence because retirement may last 40 years without earned wages to pay the bills. That means your nest egg must keep pace with the rate of inflation or you won’t be able to afford the things you need and want over the long run. To illustrate this, note the prices to attend the top grossing movies over the years. Watching Luke Skywalker battle Darth Vader in The Empire Strikes Back in 1980 would have cost you under $3, while viewing your favorite Marvel characters in Avengers Endgame would have been over $9 if you could have found an open movie theater during the pandemic in 2020! This represents a 4.4% rate of inflation which may not mean much until you reframe it in terms of actual cost increase. Realizing the cost of going to a movie more than tripled during the span of a typical retirement might have more impact. Apply this across all the things one needs or enjoys for four full decades, and it is easy to see why financial advisors consider inflation to be a primary enemy, and why growing a portfolio is necessary to combat it.