Inflation and Your Retirement
Inflation is a hot topic today. In fact, inflation is leading to the highest Social Security cost of living adjustment ever in 2022. For over 70 million Americans, they’ll have their benefits increased by 5.9% [1].
However, when it comes to retirement planning, there’s a lot of concern with inflation because many people didn’t account for inflation when coming up with their overall strategy to secure their retirement.
We’re going to be covering inflation and what it means for your retirement.
What is Inflation?
Inflation is a word that many people know, but they don’t really understand what it means in the whole spectrum of things. The term “inflation” relates to the increase in prices in an economy over time.
You’ve probably noticed the costs of the following items have risen:
- Groceries
- Automobiles
- Gas
- Airplane tickets
In 2020, when the pandemic was running wild, the government pumped billions of dollars into the economy to keep everything running. Supply was a major issue at this time, so people couldn’t even purchase toilet paper.
However, manufacturers increased prices because the demand still existed.
Essentially, inflation makes your dollar worth less. For example, if you purchased a food item for $1 a year ago and it now costs $1.10, your dollar is worth less because you get less for your money.
Deflation also exists, but it’s far less common.
When deflation occurs, your purchasing power increases.
Inflation is often portrayed as a bad thing, but it means that innovation is ongoing and that wages, hopefully, go up, too. However, with inflation rising rapidly like it is now, many people panic, especially in retirement or when employers aren’t offering salary increases to cover the cost-of-living increase.
Overview of the Inflation Over the Long-Term
When we work with clients, we like to go off of the 100-year average for inflation. Over 100 years, you’ll see a lot of periods of inflation and deflation, but the average inflation rate is just over 3%.
However, when you look at the last ten years, inflation has been at about 1.5%.
Since inflation rates over the past decade have been mild, it’s difficult to adjust to rising levels. If you think about the toilet paper crisis, high demand and low supply led to rising prices.
Thankfully, supply issues are easing, so we can expect supply and demand to equal out.
Another example of this is the housing industry. We’ve seen a lot of people’s homes going into bidding wars, with a lot of houses selling for more than they’re worth. However, this trend is expected to slow as inventory increases.
For people in the workforce, rising wages should help combat the rise in inflation.
Anyone who is already in retirement or planning to retire shortly will want to take additional steps to prepare for potential inflation.
5 Crucial Things to Consider When Preparing for Inflation in Your Retirement Plan
1. Long-term Fixed Income Investments
If you have long-term investments, such as government or corporate bonds (where the maturity date is 10, 15 or even 30 years), the long-term rates may not be as attractive as when you first purchased it.
Be sure to check your fixed-income investments, especially with high inflation, because they may no longer provide the returns necessary to cover inflation.
This doesn’t mean that you shouldn’t have any long-term investments like those mentioned, but you may need to readjust.
2. Risk Management for Your Portfolio
You need to have good risk management for your portfolio. It’s crucial to protect your portfolio so that if you lose 30% of it, you’re not struggling to make it back. A good analogy that we like to use is that if your portfolio drops 50%, you need to make a 100% return to recuperate your losses.
Let’s look at this with real-world figures.
If you have $100,000 in the market and lose 50%, you’re down to $50,000. However, if you gain 50% in the coming years, your portfolio is only up to $75,000.
It’s always better to protect your portfolio than try rebuilding it.
Good risk management protects against these losses so that they are minimal.
3. Think About Your Guaranteed Income
Guaranteed income is vital to your retirement, and this includes things such as:
- Social Security
- Pension
- Etc.
If you know your needs and wants, you should have as much of your needs covered by guaranteed income. You should try and cover most of your expenses with guaranteed income so that you’re less impacted by inflation.
Growth buckets can help cover the increase in inflation.
4. Maintain a Good Spending Plan
Many people retire without any type of spending plan. Unfortunately, without a plan, you’re putting your retirement at risk. You should plan based on:
- How you’re spending money
- Essential needs (food, utilities, housing)
- Wants (cars, vacations, etc.)
- Legacy (charities, kids, etc.)
When you have a general idea of what you spend monthly, you can devise a spending plan. A good way to find out what you’re spending is to use Mint (it’s free), which will categorize your expenditures so that you can see and understand where your money is going.
5. Sit Down with a Financial Professional
If you have a financial planner that you work with, sit down with them and begin the difficult discussion of inflation and your retirement. When we sit down with clients, we do a few things:
- Flush out a retirement plan before they become clients
- Run plans and stress them out based on low rates of returns
- Run plans at a 3% inflation plan
- See how the retirement plan works through these tests
When we run tests for a person’s retirement, we can use the worst-case scenario and make adjustments based on this. For example, we may find that the person needs to work a few years longer or work part-time to retire.
Through tests and the help of a financial advisor, it’s possible to learn whether you have enough money for retirement and to stave off inflation.
Inflation will remain a consistent concern through retirement. Still, if you plan ahead and consider some of the points we’ve outlined above, we’re confident that you’ll be able to retire with peace of mind that you’re protected against inflation.
Do you want to follow an easy, four-step course that can help you secure your retirement?
Click here to access our FREE course, titled: 4 Steps to Secure Your Retirement.
Resources
- https://www.ssa.gov/cola/