One million dollars might sound like enough to retire with today, but by the time you reach your last day of work, it will be worth less than you might think.
The reason is inflation, and it affects how you plan for the future.
“Inflation is the silent killer of your financial plan,” said Derek Brainard, manager of education services at AccessLex Institute, a nonprofit that helps law students understand their finances.
When putting away money for retirement, Brainard said, “you might need to be saving a lot more than you think because of inflation.”
The long-term average rate of inflation is between 2 and 4 percent annually, based on data from the Bureau of Labor Statistics’ Consumer Price Index, one of the most common measurements of inflation. So, if you kept money in a safe, it would be worth 2 to 4 percent less per year.
You can’t stop inflation, but you can make your money work better for you. These two strategies can help:
1. Invest your money for retirement with a 401(k) or IRA. You might already do this, but you might not know why it matters: These accounts are your best bet for earning long-term returns that beat inflation.
Investing in the stock market through brokerage accounts such as 401(k)s and IRAs has led to an average return in the past century of about 10 percent annually. When you factor in inflation, that leaves the real return closer to 6 to 8 percent.
2. For short-term savings, find a high-yield certificate of deposit. Some online banks and credit unions have one-year CDs with annual percentage yields higher than 2 percent and five-year CDs with APYs over 3 percent. These federally insured bank accounts lock up funds for a fixed period, so they are best for money you don’t need for months or years.
Investing to curb inflation’s effect is smart, but you also need savings outside of CDs and brokerage accounts to cover emergencies. An emergency fund should cover three to six months of living expenses, and it should be held in more accessible interest-bearing savings accounts. It’s also important to revisit how much you need in an emergency savings account because of higher costs due to inflation’s affect on the cost of living.
Written by Spencer Tierney at NerdWallet. E-mail: firstname.lastname@example.org. Twitter: @SpencerNerd