What Impact Does Inflation Have on Your Retirement Savings?

The G fund inside of the Thrift Savings Plan is known as the “super safe” selection of the TSP funds because it never loses money. But how does it perform over the course of an entire career?

Most of us plan to retire someday. In order to do that, it is essential to devise a financial plan that puts you on a path to eliminate debt and save money over the course of several decades of working.

But how you save money can have a substantial impact on how much money you are left with at retirement. Savings vehicles that earn little to no interest can leave you with a net financial loss over time even though they do not technically go down in value. Why is this? In a word, inflation. Let’s examine why this is the case.

For federal employees, the Thrift Savings Plan (TSP) is the default retirement savings plan that one can use to save money over the course of a career with the government. It offers federal workers some basic funds in which they can invest their money.

Performance of the G Fund

The G fund is known as the “super safe” selection of the funds because it never loses money. Investing in government treasury bills, the fund earns a small but steady rate of interest and indeed it has never earned a negative rate of interest since it has existed, meaning your principle will not go down in value.

Enter inflation. Since 1914, the average inflation rate has been roughly 3.3%. Over the last decade, inflation has averaged around 2.38%.

The G fund’s average annual return since its inception in 1988 has been about 5.43%. For the last decade, it’s averaged 3.19%.

From a savings standpoint, this means that you have only a small amount of cushion for growing your money. In the last decade, the effective return on your investment would be only 0.81%. (3.19% – 2.38% = 0.81%).

What does this mean in practical terms? A hypothetical $10,000 investment which began in 2005 would have only grown to $10,840.17 over 10 years at a 0.81% interest rate.

Performance of the C Fund

Let’s contrast this with the TSP’s C fund. Over the last decade, the C fund has an annual average return of 7.72%. Even if you back the 2.38% inflation rate out of this, that still leaves a return of 5.34%. That same hypothetical $10,000 investment in 2005 would be worth $16,824.15 after 10 years, a much better return.

These figures are using modest numbers and assume no other contributions will be made on a regular basis to the investment principle. The returns get much better when you consider that you will be regularly contributing each month to your TSP account from your paycheck, and that the C fund has averaged almost 11% annually since its inception in 1988.

How might an 11% return look over the course of a 30 year career? Here are some hypothetical numbers:

If you started with $1,000 and contributed $300 per month over the course of 30 years, the total account value would be $541,071.66, assuming an average annual interest rate of 8% (11% average annual return for the C fund minus 3% for inflation).

The Cost of the G Fund

What if you were to have gone with the G fund instead? Starting with $1,000 and investing $300 per month over 30 years at an average annual interest rate of 2% (5% average rate of return for the G fund minus a 3% inflation rate), your account balance at the end would only be $167,079.64. That’s a difference of $373,992.02.

All of these numbers look even better the more you contribute and the longer your time frame is for investing. The annual contribution limit for the TSP in 2015 is $18,000. That works out to $1,500 per month. Agencies make matching contributions as well which is free money to you, something you absolutely must take advantage of to maximize your long term savings.

Inflation also has a compounding detrimental effect over time to the intrinsic value of your money. $10,000 in 1983 is now equivalent to about $23,389.26. This represents a cumulative inflation rate of 133.9% over that 30 year period.

While you can “play it safe” with some of the TSP funds, you may find that over the course of an entire working career you are actually taking a risk with your money.

You should always consult a qualified financial advisor for outlining the best course of action for your personal situation, and always be sure you understand an investment before putting money into it. The right financial planner can help guide you in these important decisions as you save and invest for your future.

About the Author

Ian Smith is one of the co-founders of FedSmith.com. He has over 20 years of combined experience in media and government services, having worked at two government contracting firms and an online news and web development company prior to his current role at FedSmith.