How Much Does A Dollar Cost?

Includes: UDN, UUP
by: Chip Castille

Take a dollar out of your wallet and have a good look at it. What's the first thing that comes to mind? Most likely, it's what that dollar will buy -- although, admittedly, that's not very much. But even if a dollar doesn't buy what it used to, we still think of a dollar in terms of purchasing power.

But what if there was another way to think of a dollar? What if the way we should think about a dollar is not what it buys, but what it costs -- and more importantly, what it will cost at some point in the future? If we can reasonably estimate the future cost of a dollar, would it change the way you plan for retirement?

A Dollar Today, a Dollar Tomorrow

Before we can answer these questions, let's explain what we mean by the cost of a dollar by reverse engineering the problem. If you went back 20 years to 1993, what would be the cost of earning a nominal dollar in 2013? It's a complex problem to solve. You would have to account for inflation, but you should be able to offset some of its corrosive effects by leveraging interest rates and investment returns. If you had an actuarial frame of mind, you might even negotiate a discount based on the likelihood that you would live until 2013 to collect your dollar.

If this sounds like the thinking that goes into pricing annuities, it's intended to. Insurance companies are in the business of pricing (and delivering) future income. If we can harness some of the insights of their pricing models and make them easily available to individuals, we would have a powerful new way of helping people understand how their current savings might support their future spending.

From Retirement Savings to Retirement Spending

As they near retirement, most people look at their savings balance and try to determine how long they can make it last. That's a difficult thing to do as an individual, in large part because we don't know how long we are going to live. Insurance companies, by contrast, have the advantage of pooling together large numbers of people and use mortality tables to predict future payouts.

BlackRock has introduced a series of indexes and an online tool designed to help individuals solve that problem. Currently, there are 10 BlackRock CoRI Retirement Indexes, one each for people from the age of 55 to 64 that estimate on a daily basis the cost of one dollar of annual lifetime income beginning at age 65. For instance, a CoRI Index Level of $16.42 means that you should have $16.42 today for each dollar of annual lifetime income you'd like to begin receiving at age 65. The index levels are calculated using many of the same real world factors used by annuity companies, including life expectancy and inflation adjustments. What the CoRI Indexes give you is a new way to think about retirement planning. They provide an estimate about the cost of a future stream of dollars, or what you may need to save to produce a desired future lifetime income.

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