About the inflation calculation
Inflation compounds exactly like interest, just against you. At 6% a year, prices double roughly every twelve years — which means a retirement plan built on today's expenses understates the real requirement by a factor of two or three over a normal working life.
Formula
Future cost = Present × (1 + i)^t
Purchasing power = Present ÷ (1 + i)^t
i = inflation rate as a decimal
t = yearsWorked example
Something costing 100 today, at 6% inflation for 10 years: 100 × 1.06¹⁰ = 179.08. Put the other way, 100 kept in cash will buy what 55.84 buys today.
Frequently asked questions
What inflation rate should I use?
Long-run averages of 2 to 3% are typical for developed economies and 5 to 7% for many emerging ones. Your personal rate may be higher: education, healthcare and housing have generally inflated faster than headline indices.
What is a real return?
Your nominal return minus inflation. A 10% return during 6% inflation is roughly a 4% real return. Only the real figure tells you whether you can actually buy more than before.
Why does inflation matter so much for retirement?
Because a retirement lasts decades with no salary rising alongside prices. Expenses of 50,000 a month today become around 160,000 a month after 20 years at 6%. Any plan quoted in today's money is badly understated.
Sources
- Standard compounding applied to price levels