Future dollars

This is an extract from The Poor Man’s Guide to Financial Freedom: A Realistic, 10-Step Manual for Building Liberating Wealth on a Low to Medium Income.

Future Dollars

Most readers looking at retirement will be thinking of doing so some years down the track.  That changes our calculations because we need to be thinking in future dollars rather than present dollars. 

Huh?

Because of inflation, future dollars will almost certainly be worth less than today’s dollars.  This is easy to demonstrate with a couple of examples:

In 1985 a stamp in the USA cost 2 cents.  Today a stamp will cost you 49 cents. 

The entire Apollo Moon program cost a total of $24 billion dollars through the 1960s and 1970s.  These days NASA receives an annual budget of about $20 billion yet they can’t afford to send their astronauts much further than the corner store. 

Prices of things usually rise over time, meaning each dollar gradually loses its value.  You’ll need more of them to retire in the future than you would to retire today.

How much do prices rise?  Let’s have a look at some rates of inflation across a selection of countries to get a rough idea:

Country                                     .	Most recent inflation estimate
Saudi Arabia	-0.9%
Japan	1.5%
Australia	2.1%
United States	2.1%
United Kingdom	2.7%
South Africa	5.3%
Argentina	54.7%
Zimbabwe	175.0%
Venezuela	50,100%
Source: Wikipedia[i]

The future is unknown, but history suggests that the annual inflation rate for a normal country tends to average around 2-3% a year.  It might be less.  It might be more.  As you can see, in rare cases it can shoot right up, as in the last three (basket) cases on the list. 

In other circumstances, overall prices can actually fall (called ‘deflation’), as in Saudi Arabia.  Assuming an annual inflation rate of around 3% is a reasonable, slightly pessimistic estimate so let’s go with that.

Say you decide that you want to retire on $20,000 per annum in today’s dollars and you calculate, by multiplying that amount by 25, that you’ll need around $500,000 to do it.  Imagine that you don’t have the money yet (easy enough to imagine, I guess) and you plan to save and invest to do it as soon as possible. 

How much will you need in future dollars?  There are two ways to figure it out:

First, you can use this online calculator to estimate what the total required might be in the future:

www.vertex42.com/Calculators/inflation-calculator.html

Set the inflation rate to 3%.

Second, if you want to do it yourself with a calculator, here’s what to enter:

For one year:  [500,000]  [+]  [3] [%]  [=]   (you should get 515,000)

For two years:  [515,000]  [+]  [3] [%]  [=]   (you should get 530,450)

And so on.  Note that for the second year you were adding 3% to $515,000, not to the original $500,000.  This is very important.  It’s called compounding, and it means that the rate of increase itself will actually increase over time.  More on compounding soon.

Okay, so let’s look at what happens to that required $500,000 over time:

If you were to retire in five years, you’d need around $580,000 in future dollars.  In ten years, you’d need around $672,000.  In twenty years, it would be $903,000.

Don’t panic!  It may look like the amount you need is receding from you like a rainbow from a pursuing fool.  But unlike the fool, you have a trick up your sleeve to get to the pot of gold.  

Remember how that horrible thing called compounding makes the rate of increase itself increase?  Well, you will learn to love compounding.  Some have even described it as the eighth wonder of the world.  In some religions it is prohibited, perhaps because its awesome powers too closely resemble witchcraft. 

In the next chapter we’ll look at how to use compounding, as one might harness the power of a supernova, in order to turbo-charge your wealth and chase down that rainbow of financial freedom.

Summary

Before we do that, let’s recap this chapter: you need to figure out what your financial goals are beyond paying off your debts and avoiding catastrophe.  Let’s look at a couple of examples:

Sensible Steve, age 25
Goal	Timeframe	Today’s Dollars	Future Dollars
Deposit on a house	5 years	$50,000	$57,964
Retirement, age 55	30 years	$1,000,000	$2,427,262

Chilled Chad, age 25
Goal	Timeframe	Today’s Dollars	Future Dollars
Retirement, age 40	15 years	$600,000	$934,780

Here I am assuming that Sensible Steve is anticipating a conventional life, while Chilled Chad plans to move to a cheaper country in order to enjoy retirement sooner.  The future dollars for Steve’s retirement are calculated for 30 years ahead.  Those for Chad are for 15 years in the future.

Jot down your own financial goals like this, check that they are realistic using the calculators provided, then read the following chapter on investment in order to figure out how to get there.

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[i] https://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate

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