When you set up your KiwiSaver targets and goals, you need to account for inflation, or risk not having enough money when you retire.
What is Inflation?
Inflation is basically a measure of rising costs in a country. An example is that $1 mixture of lollies that was a week’s worth of treats in the 1980’s, won’t even last a day now. In New Zealand, the average rate of inflation had been around 2.15% per year since 2000; so something that cost $100 one year would have increased to $102.15 the next. And while it doesn’t sound like much when thinking about a single item, when it’s across the board and everything goes up – even at that low rate – discretionary spending becomes tighter as money is directed towards the now more expensive everyday essentials.
Inflation happens when there’s more demand than supply. This could be because there is a period of prosperity with plenty of disposable cash, or because there’s shortages of goods or labour. Some years it can be high, other years, minimal. It’s dependent on the international situation as well as the domestic one. While the government can try to minimise it, there’s only so much they can do, especially when international forces are at play. Inflation is a fact of life and it doesn’t always remain consistent or predictable. Disrupt the demand/supply equation (e.g. pandemics, wars, supply chain disruption, low unemployment) and you will see that flow through to inflation. The bigger the disruption, the bigger the impact.
How Does Inflation Affect Me?
Aside from increases in costs on everything you buy, inflation also affects your retirement savings. Inflation effectively decreases the value of your savings, as $100 now will not have the same buying power next year and for certain, when you retire.
The very worst thing you can do is put your money in the bank and then forget about it. This is because the ‘cost’ of inflation is likely to be more than the interest you’re earning. So that $100 earns 1.5%, at the end of the year, it’s $101.50. But inflation was higher at 2.15%, so your purchasing power decreased $0.65 that year. If inflation is running at 6.9% your purchasing power has decreased $5.40. Ouch! Year on year, and on bigger sums, it adds up, and up, and up – even when inflation is low.
What Does Inflation Do to My KiwiSaver?
There’s some good news, and some bad news.
Your return rate on your KiwiSaver should be higher than an interest rate in a bank. This is the good news. Assuming you’re making 6% annually in your high-growth fund, that $50,000 does much better, and over ten years, you make $39,543, so your total investment is now $89,542. Over 30 years, your balance becomes $287,174—lush, you’ll be able to afford gold flaked hamburgers in your retirement!
But wait—now, for the bad news.
If NZ’s inflation had continued to be 2.15% per year, the ‘real’ value of your investments drops. After ten years, your dollar value would be $89,542, but it will only be worth $72,252 in today’s value. That 30-year value drops from $287,174 to $150,873. However, when you factor in periods of higher inflation, your end purchasing power will most definitely not extend to gold flaked hamburgers!
What Does This Mean for Me?
Inflation is unavoidable. It’s a fact of life in every country across the world. In countries experiencing financial challenges, wars, or social upheaval, it can be incredibly high, well into the realm of 20% or more. When we read news articles decrying New Zealand’s current rate of inflation, reporters invariably fail to mention that inflation between 1970 – 1990 never dropped below 5.72% and reached as high as 17.15% in 1980!
Inflation, at any rate, is something you have to plan for.
Your KiwiSaver forecasting must take inflation into account. When you’re thinking about how much money you will require during retirement, you need to include inflation. If you decide you will need $500,000 in retirement, and you’re retiring in 30 years, that figure will be more like $1,000,000 ($500,000 + 2.15% accumulating per year =$926,579).
While your investments will fluctuate over time, they should out-perform inflation in the long term. As long as you are tracking ahead, you’re doing ok. However, if you have any of the following scenarios, it’s time to reassess your finances.
- You have money in the bank that’s not keeping pace with inflation
- You have term deposits that aren’t making enough money
- Your KiwiSaver is in a conservative fund and you’re still a long way from retirement
- The returns from your KiwiSaver are low and the investments are not performing
- The fees on your KiwiSaver are eating away at your profits
You also need to look at your wage/ salary. If your income is not increasing to keep pace with inflation, in real terms, you’re earning less and less each year. So, ensure your employer provides a base rate increase to keep pace with inflation at the very least. This also means your contributions to KiwiSaver will increase (minimally, but at the same rate as inflation).
Inflation Happens. Let’s Deal With It.
If managing inflation in your retirement savings feels a bit overwhelming, contact us at Sam Kodi. We can help you plan for your retirement savings goal that factors in inflation. There is no way to stop inflation, so you need to manage your money to deal with it.