When you’re planning for the future, it’s important to think about how much your money will be worth in terms of what it can buy. Money loses value over time because of inflation, which means that prices generally go up. So, even if you save a lot of money, it might not be worth as much in the future as it is today. To understand how much you’ll actually have when you retire, you should think about your savings in terms of “today dollars.” This helps you see how much your future savings would be worth if you had that money right now. Think of it this way: imagine you could buy a nice new car today for $25,000. If prices double over time because of inflation, when you retire, that same car might cost $50,000. If you save $50,000 for retirement, it might seem like a lot, but it would only buy you one car, just like $25,000 would today.
By thinking in “today dollars,” you can better understand how far your savings will go when you retire.
Simulated Scenario for a 24-year old
A 24-year-old individual plans to save $500 a month by investing in an index fund, composed of 50% Nasdaq and 50% S&P 500. All dividends will be reinvested tax-free until retirement at age 64. How much would the savings be worth, in real terms, under the following scenarios considering inflation?
- The average annual growth rates are 4% for Nasdaq and 6% for S&P 500, with an annual inflation rate of 2%. Amount at retirement : $347,451.
- The average annual growth rates are 12% for Nasdaq and 9% for S&P 500, with an annual inflation rate of 3.5%. Amount at retirement : $878,969.
- The average annual growth rate is 5% for both Nasdaq and S&P 500, with an annual inflation rate of 1.7%. $377,689
In the examples, we calculated how much you would have at age 64 if you saved $500 a month in an index fund that invests 50% in the Nasdaq and 50% in the S&P 500. We accounted for inflation to express the final amount in “today dollars,” so you can see what your savings will be worth in terms of the purchasing power of today’s money. This helps you understand how much you will actually be able to buy with that money when you retire, which is very helpful for planning purposes.
The simulation used for the second scenario data very similar to the long term averages of the Indices used. These are the statistics:
| Index/Measure | Time Period | Average Annual Return (%) |
|---|---|---|
| S&P 500 | Last 70 years | 11.2 |
| Nasdaq Composite | Last 50 years | 10.5 |
| Nasdaq 100 | Last 25 years | 15.1 |
| CPI | Last 70 years | 3.5 |
Conclusion
In the scenario the trails historically the performance of US indices, the saver will be short circa by $120,000 to becoming a millionaire, using a pure passive investing approach. The same passive approach would deliver much less with the first and third scenario that had been much worse than the historical performance of the indices. We did use a defensive approach to highlight the evaluation of different strategies for retirement, which will be covered in the next articles.
We can affirm that needs , objectives and constrains cannot be standardized, and that the help of an independent financial advisor and a path to financial education can help to clarify and identify a planned strategy which would consider the achievement of long term financial goals.
