Rate of Return: Enter the percentage annual rate of return for your investment. If you have an investment fund, you should be able to get a historical rate of return for the fund.
Marginal Tax Rate: Enter the percentage of the highest tax rate bracket to which you belong.
Inflation Rate: Enter an average annual rate of inflation as a percentage. It is impossible for you to know what this will be in the future. A conservative estimate might be around five percent. A more optimistic percentage would be two or three percent.
Single Deposit Amount: Enter the amount of your initial investment. If you are not investing anything yet, you can enter "0."
Annual Deposit Amount: Enter the amount of money you will add to your investment each year.
Years of Growth: Enter the number of years until you cash out your investment. The calculator assumes you will cash out your entire investment all at once. In reality, you will probably cash out your investment bit by bit, allowing the remaining balance to continue gaining interest. However, for the sake of simplicity, assuming you will cash out all at once makes the different investment factors easier to appreciate.
Investments, Rates of Return, and Inflation Explained
Inflation takes from your investment like a hole in your pocket. Inflation makes your money fall away just as sure as interest and rate of return cause your money to pile up. The trick is to make sure that your rate or return stays much higher than the rate of inflation.
Looking at Inflation
Inflation ultimately means that a dollar is worth less as time goes on. We all know that fact of life from our parents' or grandparents' stories of five-cent candy bars and twenty-five-cent movie tickets. If you rent housing, you may also have noticed that your rent periodically goes up, and rarely if ever comes down.
Just how much inflation there really is, is open to debate. Obviously, some things, like movie tickets (now more like $10 each) have increased in price more than others, like candy bars (a more affordable 50 cents). However, some things, like radios and television sets, have gone down drastically in price over time. Costs in specific cities or regions may even accelerate faster than in other cities and regions.
In fact, people disagree as to just how much prices have gone overall and there is no single agreed-upon measure of inflation. The most commonly used measure in the US is the consumer price index. The consumer price index looks at important expenditures for daily life in the United States on average. This measure has historically been around a few percentage points on average. Currently, it is at an historic low of around two percent.
Your own cost of living may go up or down differently. If you are considering moving to a higher-cost of living area, this is important to remember when planning your finances. If you are planning on an active retirement involving travel, further education, or other activities that come with a price tag, remember those cost increases as well.
Inflation is the most important reason for seeking out a high rate of return on your investments. High-return investments, such as most stocks, often carry a real risk of losing money. Yet due to inflation, low-return investments carry another risk: that inflation will eat away all your low-return gains. You need to balance the risk of losing money on an investment vs. the risk of not making enough money on the investment. There is no one universal rule for making this decision. However, financial advisors generally say that the more time you have to stay invested (usually this means the longer you have until retirement), the more risks you can take. That's because if you take a risk now and lose, you might make back your losses and then some in the future. But if you only have a limited number of years until you need to cash out your investment, a sudden loss could be catastrophic. In short, your best bet for beating inflation is to start investing as soon as possible so that you can more safely invest in riskier ways such as a stock fund.