Why you need to consider inflation when planning for the long term

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By Dr. Jim Dahle, WCI Founder

I recently listened to a 99-year-old doctor talk about his salary as an intern. He was paid $15 a month. You and I can't even fathom that. That $15 is nothing more than a decent fast-food meal for a single person these days. How long will it take before my intern salary ($34,000 the day I signed my contract after placement) makes current residents laugh? My residency program was never known as a particularly well-paying program, but now it pays interns $61,508, which is almost double my salary.

The negative effects of inflation

Inflation is not only real, but it will have a serious impact on your life. You need to make sure your salary, annual savings, and nest egg keep up with or outpace inflation, or it will slowly but surely eat into your standard of living. In your lifetime, you'll also likely experience a period or two of fairly high inflation. Inflation (as measured by the CPI-U) recently peaked in 2022 at just over 9%, but in the 1970s it reached nearly 15% and stayed above 10% for 2 1/2 years – $1,000 in 1972 was equal to $2,300 in 1982, just 10 years later.

Get used to thinking about money in inflation-adjusted (real) terms. Use a real, not a nominal, return in your calculations. Yes, the stock market has averaged 10.81% returns since 1871. But if you annualize those numbers, it's only 9.16%. And if you look at them adjusted for inflation, the return drops to 6.91%. If you do your long-term calculations using 10% (especially for a portfolio that isn't 100% stocks and other risky assets), you're likely to be very disappointed. Personally, I use 5% real because not all of my portfolio is invested in risky assets (60% stocks, 20% bonds, 20% real estate).

The time value of money is the concept that you should get paid more if you spend (or receive) your money later rather than now. This is not ONLY compensation for the loss of the use of your money. It is also compensation for the loss of purchasing power of the money.

When Katie and I created our original financial plan in 2004, we planned to have a nest egg of $2.7 million to be financially independent. But $2.7 million in 2004 is $4.4 million today. To get to $4.4 million instead of $2.7 million, we had to increase our savings each year.

With our original plan to save $50,000 annually for retirement, we would not have reached our goal by the desired date.

More information here:

There is no short-term protection against inflation

There was no golden age of medicine (at least not for doctors’ incomes)

How to create an investment portfolio for long-term success

The “good” effects of inflation

Of course, not all of the effects of inflation are bad. Tax brackets increase each year with inflation. The highest tax bracket (35 percent) started at $326,000 in 2005. Today, the highest bracket (37 percent) doesn't hit you until you're almost $700,000, and the 35 percent bracket doesn't start until about $462,000.

Contribution limits for retirement accounts also increase with inflation, and you may be able to make additional contributions as you get older.

Inflation also makes debt easier to pay off. My parents bought the house I grew up in in 1979 for about $100,000. When they were ready to pay it off 25 years later, the monthly payment was relatively insignificant compared to their overall financial situation. This effect is not that large year to year (at least in most years), but over decades it is enormous.

Long-term real estate investors are very familiar with this. They increase the rent every year and many of their expenses increase every year, but their mortgage stays constant and becomes a smaller and smaller part of the total expenses until it disappears completely (unless cash-out refinances are done). Also, the value of the house (with the land attached) tends to more or less keep up with inflation.

The bottom line is that you can't ignore inflation. While it sometimes helps you, most of the time it has a negative impact on your finances. Be sure to take this into account when protecting your income and nest egg for retirement.

Need to create a financial plan? Check out the Fire Your Financial Advisor course! It's a step-by-step guide to finding your own path to financial freedom. And even better, we now have separate courses for physician assistants, residents, and medical students. Try it risk-free today!

What do you think? How has inflation affected your life? How old are you and what was your internship salary? What did your first house cost and what is it worth today? How do you protect your income and nest egg from inflation? Comment below!