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Predicting the Future (Future Value, That Is)

Reasons to Save

The happy outcome of saving is that you have money to buy stuff in the future. The goal, of course, is to have your savings retain buying power. Thinking of our house example, while you may have $11,000 by the time you turn 35 to use as a down payment for a house, you have to make sure that by the time you turn 35, $11,000 will be enough for that down payment. Even if it's enough today, it may not be enough in 15-20 years if the price of houses goes up.

Pizza Math

Pizza seems to be a recurring theme, so let's talk about future value and inflation in terms of pizza. Let's say you can get a slice of pizza for $1.00 today (maybe at the convenience store). Although we can't know how much the general price level will increase over 50 years, let's assume it's three percent each year. If the price of pizza increases by the inflation rate, one slice of pizza by the time you retire will likely cost about $4.38 (use a calculator to verify!). If rather than buying a $1.00 slice of pizza today, you put that $1.00 in the bank and earned 3% until you retire, you would have $4.38—exactly enough for one slice of pizza 50 years from now.

Key point: With inflation, $4.38 in 50 years will not buy what it buys today; it will only buy what $1.00 buys today.

Future Value and Inflation

If the average rate of inflation is 3% per year, the goal is to make sure your savings earns a minimum of 3% each year so that you can buy the same amount of goods and services in the future. Again, that would be the goal. However, even if inflation rates become higher than savings interest rates, this does NOT mean you shouldn't save. One does not negate the other. Even if you lose some buying power, there are still important reasons to save. Simply put, it will be much better to retire with money that may not buy quite as much as it did 20 years ago than to retire with no money at all!

In reality, periods of high inflation are rare. Interest rates and other returns on investment, such as the returns you may get in the stock market or the yield you may get on government bonds, generally exceed the inflation rate. So, saving now for the future is always a good idea!