By Dr. Jim Dahle, WCI Founder
I was recently listening to a 99-year-old doctor talk about his internship salary. He was paid $15 per month. You and I can't even relate to that. That $15 is nothing more than a robust fast food meal for a single person these days. How long will it be before my internship salary ($34,000 the day I signed my contract after the match) causes current residents to guffaw? My residency program has never been known to be a particularly high-paying program, but it now pays interns $61,508, which is getting close to twice what I earned.
The Bad Effects of Inflation
Inflation is not only real, but it will have a serious impact on your life. You must ensure that your salary, your annual savings amount, and your nest egg keep up with or beat inflation, or it will slowly but surely impact your standard of living. In your lifetime, you are also likely to have a period or two of quite high inflation. Inflation (as measured by CPI-U) peaked at just over 9% recently in 2022, but in the 1970s, it hit almost 15% and stayed over 10% for 2 1/2 years—$1,000 in 1972 was the equivalent of $2,300 in 1982, just 10 years later.
Get used to thinking about money in after-inflation (real) terms. When you do calculations, use a return figure that is real, not nominal. Yes, the stock market has historical returns averaging 10.81% since 1871. But if you annualize those numbers, it is just 9.16%. And if you adjust them for inflation, the return drops to 6.91%. If you run your long-term calculations using 10% (especially for a portfolio that isn't 100% stocks and other risky assets), you're likely to be very disappointed. Personally, I use 5% real since not all of my portfolio is invested in risky assets (60% stocks, 20% bonds, 20% real estate).
The time value of money is the concept that you should be paid more to spend (or receive) your money later instead of now. That is not JUST to compensate you for the loss of use of your money. It is also to compensate you for the loss in purchasing power of the money.
When Katie and I made our original financial plan in 2004, it called for a nest egg of $2.7 million for us to be financially independent. But $2.7 million in 2004 dollars is now $4.4 million. To get to $4.4 million instead of $2.7 million, our savings amounts needed to go up each year.
The original plan, saving $50,000 a year for retirement, would not have gotten us there by the time we wanted to get there.
More information here:
You Can’t Hedge Against Inflation in the Short Term
There Was No Golden Age of Medicine (at Least for Physician Incomes)
How to Build an Investment Portfolio for Long-Term Success
The “Good” Effects of Inflation
Not all effects of inflation are bad, of course. Tax brackets go up each year with inflation. The top tax bracket in 2005 (35%) started at $326,000. Now, the top bracket (37%) doesn't hit you until almost $700,000, and the 35% bracket doesn't start until about $462,000.
Retirement account contribution limits also go up with inflation, and you can make additional catch-up contributions as you get older.
Debt also becomes easier to pay off with inflation. My parents bought the home I grew up in in 1979 for something around $100,000. By the time they were ready to pay it off 25 years later, the monthly payment was relatively trivial compared to their overall financial situation. This effect isn't all that large year to year (at least most years), but it is huge over decades.
Long-term real estate investors are very familiar with this. They raise rents every year and many of their expenses go up every year, but their mortgage stays constant, becoming a smaller and smaller part of the total expenses until it disappears completely (barring any cash-out refinances). Plus, the value of the house (with its land) tends to more or less keep up with inflation.
The bottom line is that you cannot ignore inflation. While sometimes it will help you, it will have a negative impact on your finances most of the time. Make sure you're taking that into account as you protect your income and your retirement nest egg.
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What do you think? How has inflation affected your life? How old are you and what was your internship salary? What did your first house cost and what is that house worth today? How are you protecting your income and your nest egg from inflation?
Spot on. Inflation kills you over decades and is why I won’t buy fixed annuities. I’d rather build up a ladder of TIPS bonds in my IRA as my guaranteed income.
Prior to the last few years, inflation was so steady, and low for so long, that I think it became considered as a constant and subtle thing, to the point that lazy math became ingrained.
Still amuses me that politicians use “millionaire” pejoratively when it’s far more modest a net worth these days!
Graduated med. school in 1977. Internship at the famed Bethesda Naval Hospital and paid 18,000 as a lieutenant in the medical corps. Never felt so rich. My civilian classmates were making $11,000-$12,500 at places like Bellevue and Stanford. Bought my first house near Camp Lejeune Marine base in Jacksonville, North Carolina for $39,000. It’s worth about $250,000 on Zillow now. Earned extra cash moonlighting up and down the coast of eastern North Carolina for about $18/hour. Only me in the ER. Sixty hour shift (Friday 6 PM till Monday 6 AM) with some superb southern meals thrown in. It’s hard to believe anything of what I just documented but it’s all true.
I wonder if the 99 yo physician might have been a true “house officer”, living in hospital residences, eating at the hospital and wearing hospital issued clothes, so the $15 per month didn’t need to cover our current personal overhead. And if they were on call every 2 or 3, they probably didn’t have much opportunity to spend money. Still, that wasn’t very much money. Using 1950 dollars, it is $195.77 per month on one on-line inflation adjusting calculator.
I’m a believer and take this seriously. Can you hyperlink to HOW to incorporate this well into a financial plan? I recall the traditional methods are riskier assets (stocks instead of all bonds), real estate tends to keep up, etc.
I currently have a 90-10 stock/bond allocation, and use a 4% projected growth rate (which is lowered to account for inflation). This keeps my target FI number in dollar amounts that make sense to me now.
If you worry a lot about inflation, index more of your bonds to it (TIPS, I bonds) and make sure a big chunk of your portfolio is in assets expected to keep up with or beat inflation long term such as stocks and real estate. You may also want a little money hedging in something like commodities, crypto, precious metals etc, but no guarantees there.
Inflation is a hidden tax that disproportionately affects the poor.
Bitcoin fixes this.
Heck of a statement. So Bitcoin stops inflation? Or stops it from affecting poor people? If they’re poor, how much Bitcoin can they possibly own?
When using after inflation returns for your spreadsheet, I believe it has previously been discussed that you can use the same number for new invested capital each year projected into the future.
How do you adjust your new invested capital target as inflation actually happens?
i.e. if 3 years ago the target was saving 100k, how do you determine the savings goal for this year?
What’s inflation been over the last 3 years? Use CPI-U unless you have a more accurate number available.