Are we prepared for the sobering ‘compounding effect’?
I turn 59 this year, so it is fitting that my reading of late has been around the topic of financial planning for retirement.
Granted I have – and I hope you have, as well — been “planning” for retirement since I began work in 1986. And I still have some years and fuel in the tank before official “retirement.” But two recent articles – one dealing with Social Security and the other with 401K savings – mentioned the term “the compounding effect.” That is, the effect of time, money and interest rates to grow a savings account exponentially.
Unfortunately, this same concept of compounding works against us, as well. And, herein, lies my plea in this blog entry.
For a good decade-and-a-half now, we Americans have been lulled to sleep by what some may argue have been artificially low interest rates. Ever since the Great Recession circa 2008-09, we’ve enjoyed historically low interest rates (both in borrowing and savings) – that is, up to the pandemic of 2020. Since 2020, a number of factors have collided to create nearly 40-year high inflation. Arguably, a major factor contributing to inflation has been the ability – or, rather, inability – to attract and retain a workforce without generous wage hikes. In our aging services world, well over half the costs of delivering services resides in labor and labor-related expenses. So, in order to raise wages, providers must raise fees charged for their rendered services, thus unleashing, unfortunately, a vicious cycle of ever-increasing cost of care for which I see no short-term end in sight.
Now, allow me to re-introduce the term “compounding effect” and how it works in the reciprocal.
That same compounding effect works against us on prices or fees for goods and services. Here’s how: Let’s say, for instance, that for the next several years providers of aging services are forced to raise rates by 5 percent annually. For those of us around 60, let’s play that out over several years to a time we might begin availing ourselves of aging services – say, at age 78. For illustrative purposes let’s say the current monthly service fee a retiree would pay to move into a retirement community is $4,000 a month. And now let’s add in the “compounding effect” of 5 percent 18 years from now.
The result is a whopping $10,800 per month, or well more than double the cost today.
I’ll admit this is a fairly aggressive interest rate assumption. I suspect (and let us all hope) it’s a tad on the high side. But I would bet it’s not too far removed. Why? For one, demographics. A lot more Americans are aging, and there are far fewer to care for them at current wage rates. This trend will not change in the short to intermediate term. On the bright side, however, that same compounding effect, while working against us on costs, should work in our favor on the amount of interest we earn on our savings accounts. However, as I write this blog, much uncertainty exists regarding where to place our excess cash in order to earn that higher interest rate.
It should be noted that I am not a financial advisor nor is this blog intended to convey financial advice. My intention is to point out the long-term effects of inflation – not just today at the grocery store, but much further from now. When we’ll need care.
Are we prepared?