By Joanna Masel
Pundits urge you to save lots of more cash for retirement. yet you can’t consume piles of stored cash; unles....
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Additional info for Bypass Wall Street: A Biologist’s Guide to the Rat Race
What return can she expect, and how does this compare to her retirement needs? If returns are likely to be good, Jen can add some luxury to her life now. She might as well enjoy her money while she is still alive, because it will be no use to her after her death. But if returns are likely to be bad, Jen should cut back and save more to make sure she has enough. Knowing whether returns are likely to be good in an absolute sense tells Jen whether she should save more or spend more. Jen also wants to know whether, at the price she paid for her index fund, stocks were a good buy compared to other options.
Recently, things have become more expensive at an average inflation rate of about 2% a year. 1 Inflation is like a negative interest rate; to calculate the “real” interest rate on Jen’s CD, she takes the advertised nominal interest rate of 2% and subtracts the inflation rate. If the rate of inflation goes up higher than 2%, then when Jen gets her CD money back in five years’ time, that money, including the interest, will be worth less than it is now. Another option is for Jen to use some of her inheritance money to pay off her mortgage.
As I write this book, inflation is 2% in the US; let’s assume it stays at that level for a while. 3 Every year, Jen could spend 5% of what her capital is worth. Even after doing that for many years, her capital would still be just as valuable as it is now. Five percent of $700,000 comes to $35,000 per year, increasing with inflation. Jen could retire early, quitting her job now, and live on that $35,000 per year income,4 without even worrying about eating into the value of her capital. Jen’s position would actually be better than that, because she doesn’t need to make mortgage payments anymore.