Money is only worth what it will buy

Ask people for their definition of financial risk and you’ll often hear something like, “the possibility I might lose money.” And when you ask them to define “money” the most common response has to do with the number of dollars they currently possess, in whatever form.

For most people, money is something fixed, unchanging. A dollar is a dollar, after all.

If you really give it some thought, however, the way you define “money” might just change. To illustrate, I often pose this question to attendees at my retirement workshops: “What did you spend more on – your last car, or your first house?”

This question never fails to get a few chuckles, because once you reach a certain age – typically around the time you’re thinking of retiring – the answer is almost always the car.

And the evidence confirms it. The median sale price of a home in 1980 – when today’s 65-year-old had recently turned 25 – was $47,200. And today’s baby boomer, looking to relive the golden days of young adulthood, will spend close to $65,000 for a 2021 Corvette Stingray.

We know that as inflation, of course. Things simply cost more than they used to, and it’s almost always been that way. Prices tend to rise over time, which is another way of saying that a dollar doesn’t buy what it used to. A dollar is a dollar today, but in a year it’ll be worth about 97 cents, and 94 cents the year after that, assuming 3% inflation.

And if inflation continues to average just 3% or so per year going forward, then in 30 years today’s dollar will be worth only about 40 cents.

Think of what that means for a 65-year-old couple entering retirement today. Actuaries tell us the odds are 50-50 that at least one of them will live to age 92. And there’s a 25% chance that one will reach age 96! That’s 30+ years in retirement, 30+ years after the last paycheck, and 30+ years of living in a world where every year, just about everything they need to buy will cost them more.

The investment implications are enormous.

With life expectancies – and years in retirement – much longer than our parents and their parents, we would be wise to reconsider our definitions of “money” and “risk.” Money isn’t really the dollar bill in your pocket; it’s what that dollar will buy. And risk is no longer the threat of losing money, but of losing its purchasing power.

That generous pension that you might have been offered at retirement probably did not come with automatic cost-of-living adjustments. Therefore, you face the prospect of that stream of income losing up to 60% of its purchasing power over the years it’s designed to support you.

Investing too heavily in bonds or similar fixed-income securities – which we’ve all been taught is the “safe” thing to do in retirement – might actually be risky in and of itself, just in a different form. If you’re not willing and able to squeeze down your lifestyle by up to 60% in the years when you’re supposed to be enjoying life most fully, then perhaps investing all of your life’s savings in bonds is a poor decision.

Or look at it another way: Would you take a job for the next 30 years knowing you would never get a raise? Of course not. And trying to fight off 30 years of rising costs with an income that’s fixed isn’t likely the answer, either.

I am therefore convinced that the central goal of a successful retirement today is the creation of an income that can rise through the years at least as fast as your cost of living is rising, so that the increase in your spending might be largely offset over time by rising income. The problem is that most investments – especially those that many retirees love to own – simply can’t provide it.

In my next post, I’ll show you one that can.