The Stealth Assassin of Your Best-Laid Retirement Plans
Inflation: ?When it comes to retirement, inflation has been called the "assassin" or silent killer. Inflation is in the background for all of us, when prices of consumer goods increase over time.
Have you fully considered inflation in your retirement plan?
The effects of inflation take time to materialize and may be difficult to spot, but it can silently hurt your finances if left unchecked. Talk to a financial advisor about how inflation steals from your retirement, and what you can do about it.
How Long is Retirement?
Time is one of the strongest forces in the world of money. On the one hand, compounding interest and returns can multiply your earnings over time; but the other side of the coin: Carrying high interest debt can take decades to pay off. The same is true with inflation. It takes its toll on your money over time, especially during retirement, because without working, you are not earning a paycheck, which typically rises to offset inflation. So, how long is retirement typically?
In our 50 years of experience in helping clients at Linscomb & Williams, the average retirement is roughly 20 years, but it can stretch up to 30, depending upon one's health and life expectancy. This means that your retirement planning should account for nearly two decades of retirement (at least), and that you’ll have to contend with inflation for this same period of time.
How Inflation Affects Your Retirement Plan
For one, inflation gives you less purchasing power, meaning the strength (spending power) of your saved dollars will decrease, even though the numeric value of dollars you have today is higher than the dollars you earned or saved years ago.
Inflation doesn’t affect all prices equally, either. For example, healthcare, one of the biggest expenses for retirees, has increased in the past three decades at a much faster pace than the rate of general inflation.
Therefore, it’s important that your investments earn returns that can match or exceed inflation over time. Your ability to make essential purchases on items like healthcare, food and the like depend on it.
Currently, many savings account interest rates hover between 0.40 and 0.70 percent. However, the inflation rate is 1.4 percent. This means that the money in a savings account will have negative growth of nearly 1 percent in a year until such time as markets demand that banks pay higher interest rates. Of course, your emergency savings isn’t necessarily primarily set aside for investment returns, but it’s important to recognize that holding too much cash can stifle your future growth. It is a slow deterioration to this portion of your capital, which eats away (like termites) at the strength of your assets.
Rising consumer prices are painful for everyone, but retirees are actually hurt the most, because some of the items on which retirees typically spend the bulk of their income can experience the most significant price increases.
Retirees often rely on sources of fixed income, usually coming from Social Security, pensions, and interest on bonds. Of these three, only Social Security enjoys any protection from the eroding effects of inflation. But housing, healthcare, and transportation – some of the most expensive items for retirees – can experience the most rapid price changes. Even though the current inflation rate can be considered low compared to years in the past, even low inflation rates can mean a high price during retirement. An inflation rate of 2 percent over a 25-year retirement will erode more than 40 percent of your capital, and that is before considering that you have to report the interest you earn on your savings on your tax return and share part of it with the government.
Source: U.S. Bureau of Labor Statistics, September 2018
Inflation will also affect your cost of living. Retirement planning in Atlanta will look different than retirement planning in Texas, for example, because the cost of living is different. But inflation affects both areas, making the cost of living higher overall.
Knowing the potential damage caused by inflation is only the first step. The next step is taking action to protect your retirement. There are a number of ways to preserve your purchasing power amid rising prices. Fortunately, Linscomb & Williams can help.
How to Reduce the Negative Impact of Inflation
Your Social Security payout is initially determined by the year you begin receiving payments. Generally, the longer you wait to receive Social Security benefits, up to age 70, the higher your monthly payment will be.
This may not be an appealing option for everyone, but if you can hold off receiving your Social Security benefits, you can lock in a higher lifetime income. This stream of payments is protected from cost-of-living increases, providing you a very valuable hedge.
Inflation-protected bonds and bond funds can also help. Bonds are almost part and parcel with any retirement-oriented portfolio. Since bonds pay interest annually or semi-annually and carry considerably lower risk than stocks, they can be very appealing to folks looking for a fixed income.
But most bonds aren’t designed with inflation in mind. For example, if a 10-year corporate bond currently might pay about 2 percent in returns each year, an inflation rate of just 1 percent cuts those returns in half!
One solution for more attractive bond investments is Treasury Inflation-Protected Securities, or TIPS. These bonds adjust and pay interest based on the rate of inflation.
If you own a $10,000 (face value) TIP with a 1 percent interest rate, and the inflation rate hits 2 percent that year, you will receive interest payments as if you invested $10,200 (based on a 2 percent inflation rate), not $10,000. If inflation is zero for that year, you will receive the 1 percent without adjustments. TIPs can particularly protect you if inflation escalates during the course of your retirement.
When forming your retirement plan, be sure to discuss inflation-protected investments with your financial advisor.
Holding stocks is another way to keep up with inflation. While there is no guarantee that stocks will outpace inflation necessarily, history shows that the rate of stock returns, on average, can greatly outpace inflation.
It is true that adding stocks to your portfolio mix can introduce risk to your portfolio, but inflation itself is also a risk, and a reasonable allocation to stocks can still balance nicely with your bond investments. Discuss your allocation and risk tolerance with your financial advisor.
The Current Situation
Thankfully, the inflation rate to start 2021 is still historically low. But inflation could be right around the corner. While no one knows the future, this is certainly a topic getting plenty of financial press at the current time.
Retirement planning is not a one-size-fits-all equation. Everyone’s situation, retirement personality, and goals are unique, so their plans are made up of different components. Retirement planning can be complicated and complex. A financial advisor can help you put your full situation in perspective, and custom-fit a portfolio according to your needs.
In retirement, there are plenty of obstacles and considerations that require your attention. Talk with the team at Linscomb & Williams, and remove the obstacle of worrying about inflation.