Assume we are 30 years old today, making $60,000 a year, and we plan to retire 30 years from now (m=30).  Also assume the future average annual rate of inflation will be a modest 3.0% (r = 3.0%).  Assume we want to retire on $50,000 a year in today's dollars (R_o = $50,000.  What will that amount to 30 years from now (R₁=?)?  The formula that tells us that is as follows:

    R₁ = R_o (1+r)^m  = $50,000 (1+.03)³⁰ =  $50,000 (2.42726) = $121,262.13

That says, in words, that $50,000 a year today is equivalent to $121,262.13 thirty years from now, at an average annual rate of inflation of 3%.  In other words, in thirty years, it will take $121,262 to buy the same goods and services that $50,000 buys today, if the future average rate of inflation is 3%. 

This is why savings accounts and money market accounts that earn less than the rate of inflation are a bad investment for retirement planning purposes.  You will need to seek out investment opportunities and investment instruments that historically have consistently beat inflation by a wide margin. 

©2008, Simon Revere Mouer III
all rights reserved