Inflation is increasing over the slow rate at which it grew during the last decade. No one would dare call today’s rate of inflation “rampant”, as it was 2.2% in the month of May, though many expect inflation to creep closer to 3% by year end. Since 1926, inflation has roughly averaged 3% per year. Even this modest rate of inflation can cause a loss in purchasing power if it is sustained over a long period of time.
Using the “rule of 72”, a sustained 3% inflation rate would cause the value of a dollar to be cut in half in twenty four years. An individual who retires at age 60 has a better than fifty-fifty chance of living another 24 years.
The “rule of 72” posits that if you divide a rate of inflation into the number 72, the answer is the number of years it takes for the purchasing power of a dollar to be cut in half. The “rule” can be also be used to determine how many years it would take for the value of a dollar to double. If you earned a steady 6% return on your investments, they would double every twelve years.
FERS and Social Security Indexed
Two of our retirement income sources are indexed for inflation; our FERS annuity and Social Security. Social Security has a full inflation adjustment and FERS has a modified inflation adjustment. The Thrift Savings Plan, however, is not indexed for inflation. If we want be able to adjust our TSP withdrawals for inflation, we will have to figure out how to do so. Many financial advisors suggest following what is called the “4% rule”. This rule has an individual begin withdrawing from their TSP at a 4% rate and adjusting it annually for inflation.
$500,000 sounds like a lot of money today and would yield an income of $20,000 per year if we follow the “4% rule”. If an employee started saving in the TSP today with a goal of accumulating $500,000 by the time of their retirement in thirty years, and we had inflation averaging 3% per year, in twenty four years TSP balance would give them the equivalent of $250,000 in today’s dollars; an annual income equal to roughly $10,000 in today’s dollars. This tells me that we will need more than we think we will in our TSP accounts by the time we retire.
See also Understanding Inflation and the TSP
There is good news in that every fund in the Thrift Savings Plan has outpaced inflation since its inception. On the TSP website, in the “forms and publications” section, one can find “Fund Sheets” for each of the five basic funds. These sheets list how each fund did against inflation from their inception to the end of the most recent calendar year. The inflation charts compare what $100 would have turned into if it was invested in the fund on the day of the fund’s inception, with how the purchasing power of $100 would have been eroded by inflation.
What follows is how each of the funds has fared against inflation as of December 31, 2017.
$100 invested in the G Fund at its inception on April 1, 1987 would be worth $461 today and you would need $222 of today’s dollars to buy what $100 bought back then.
$100 invested in the F Fund at its inception on January 1, 1988 would be worth $615 today and you would need $216 of today’s dollars to buy what $100 bought back then.
$100 invested in the C Fund at its inception on January 1, 1988 would be worth $2,016 today and you would need $216 of today’s dollars to buy what $100 bought back then.
$100 invested in the S Fund at its inception on May 1, 2001 would be worth $444 today and you would need $140 of today’s dollars to buy what $100 bought back then.
$100 invested in the I Fund at its inception on May 1, 2001 would be worth $234 today and you would need $140 of today’s dollars to buy what $100 bought back then.
Keep in mind the fact that the various TSP funds were introduced at different times, so the results above are not directly comparable. This leads me to believe that there’s no such thing as too much money in the TSP!