Q: What rate of return should a 20- or 30-something use when using a retirement planning calculator? (They are often preset to 6 or 8 percent). And does that include inflation? Depending on the assumptions I use, I get drastically different answers. On the low-end, Im saving too little and on the high-end, Im saving too much. What do you recommend? Kimberly

Great question. As youve noticed, a small difference in your assumed rate of return can drastically change how much you need to save for retirement. Not to mention inflation and the income youll need in retirement.

Assumed rate of return 

Ive seen people use everything between 5 percent and 12 percent for average annual returns over a lifetime of investing. But which rate of return is more accurate: 5 percent or 12 percent?

Maybe both. There are two big factors to consider:

• Whether or not the assumed rate of return accounts for inflation.
• The investment time period.

Historically, the U.S. inflation rate fluctuates between about 1.5 percent and 4 percent per year.  So if you got a 10 percent return on your investments in a year that saw 3 percent inflation, your inflation-adjusted return is more like 7 percent (thats an oversimplification of the math, but you get the idea). Remember, inflation is the whole reason you cant just stash your savings in a bank account and expect to grow wealthy. If inflation is 3 percent and youre only earning 2 percent, youre losing money!

Investment period

How long you have to invest will impact the rate of return you can expect for a number of reasons. For one, the longer you have to invest, the more aggressive you can be with your asset allocation by favoring stocks and other more volatile — but potentially more rewarding — investments. In addition, the longer you invest, the more good years you will hopefully have to overcome the bad ones. This is also why its important not to get out of the market during a decline — you risk missing out on the bounce-back.

Some examples

I pulled some numbers using this calculator  for the markets average rate of return over three 30-year periods. Ive shown the results both with and without inflation.

COMPOUND ANNUAL GROWTH RATE FOR THE S&P 500