Planning for the future creates many questions:
- What will things cost?
- Will I earn enough to pay for the things I want?
- If I’m saving for tomorrow what can I expect to earn on my savings?
- How long will it take me to save enough to pay off my student loans, buy a car or a home?
- Will I ever have enough saved to retire and support myself?
In order to answer these questions we have to make some guesses as to what the future will look like based on historical data.
What is inflation?
Inflation is the word economists use to describe the percentage at which prices are increasing every year. This percentage is found on the Consumer Price Index (CPI). Last year, home prices in Denver jumped sharply. A widely followed index of Denver home prices showed the average price rose over 10 percent. Gas prices went the opposite direction and, according to AAA Colorado, declined by 26 percent. In order to balance the changes, the government measures inflation across a basket of goods consumed by the average family. Inflation peaked at 15 percent in 1980 and has been generally declining over the past three decades. Over the past decade, the average rate was 2.5 percent.
How much will I be earning in the future?
Planning for your future will require a good estimate of how much money you will earn in future years and the cost of inflation. If you are still working, then your wages will probably grow and offset the costs of inflation. The Bureau of Labor Statistics (BLS) calculates the average hourly earnings (AHE) for all workers. Back in the 80s, wages were growing at 9 percent. Recently, wages have been increasing, but most would not get too excited over the 2.1 percent growth rate.
The Bright Side: Mortgages
You’ve probably heard that mortgage rates are at historically low rates. Well, what does that really mean?
Over the past 15 years, mortgage rates have declined from a high of 8.63 percent in 2000 to a low of 3.10 percent in 2012. Currently, the rate is near 3.5 percent. From the peak, the cost of financing a home is down 45 percent. With a 30-year mortgage, your payments are locked in for the duration of the loan. From a planning perspective, that means that the largest monthly expenditure is fixed at current levels. This means it’s a number you can count on.
Use the stock market.
If I’m looking at my retirement savings and want to project how much I will earn in the future, I want to look beyond the latest stock market returns and study average historical returns across several business cycles. The S&P 500 Index is a good resource because it is a broad-based index containing some of the largest companies. The stock market returns oscillated between large gains and losses over the past 15 years. So, using the average return of 8.9 percent is a reasonable expectation of a long run return.
The Whole Picture.
I can expect my wages to grow by about 2 percent per year. There will be some things that cost more and some things that cost less, but generally prices will go up by about 2 percent. The cost of financing my largest purchase, my home, will be about 3.5 percent. If I save some money and invest it in stocks the annual returns will bounce around, but over a longer period of time should be around 8.5 percent.
Putting the whole picture together, I can make some pretty good estimates of what to look forward to over the next few years.
Check out our post from last week related to trusting studies to plan your future.
What do you use to help plan for your future? Leave us a comment below.