Question

Lillian Coleman is 21 years old and has just graduated from college. In considering the retirement investing options available at her new job, she is thinking about the long-term effects of inflation. Help her by answering the following related questions:

1. Explain the effect of long-term inflation on meeting retirement financial planning goals.
2. If long-term inflation is expected to average 4 percent per year and you expect a long-term investment return of 6 percent per year, what is Lillian's long-term expected real rate of return (adjusted for inflation)? Be sure to consider the important impact of compounding.

__________%

Answer 1

Inflation in the long term will be going to minimise the rate of return which will be reducing the total return when invested in the long-term,so she should be trying to earn a higher rate of return which can easily beat the rate of inflation and which will be helpful in compounding her overall rate of return.

Real rate of return = (1+nominal rate of return/(1+inflation)-1

= (1.06/1.04)-1

= 1.9230% return per year.

Since the number of years for her investment is not when it is not apt for calculating the overall rate of return.