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Inflation Risk: Should You Be Worried About Inflation and Your Retirement

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Inflation is a dirty word when it comes to retirement finances. We have been lucky for a while. Over the last four decades the United States has enjoyed record low inflation rates.  However, the inflation risk might be changing and you may want to consider ways to protect your retirement from the possibility of inflation.

This week the U.S. Bureau of Labor Statistics reported that in April consumer prices jumped at the fastest pace in more than a decade. Higher prices were somewhat expected due to an increase in demand for goods and services as we emerge from the pandemic. However, the big jump surprised economists who were widely predicting a more modest increase. Inflation risk is on the horizon more than before.

No one can predict the future. Economists try, but spreadsheets are not a crystal ball for predicting inflation risk.

Here are a few thoughts about the current situation:

Is it Just Transitory?  There is a good argument to be made that this is a temporary jump. Prices fell dramatically over the last year, and it is reasonable to see an increase to at least pre pandemic levels as the economy comes back to life.

There is currently increased demand for goods and services but also supply bottle necks that are driving up prices. Many people believe that as these trends normalize, inflation will cool off.

Might prices continue to rise? While runaway inflation (like that seen in the 1980s) is unlikely, some experts are predicting more inflation growth than we have seen in a long time.

When prices go up for some things, it makes it more likely that other businesses will also raise prices. As Kristin Forbes, an economist at M.I.T. and a former official at the U.S. Treasury and the Bank of England told the New York Times, “Now the genie’s out of the bottle. If everybody else is raising prices, it becomes a lot easier for you to do that, too.”

What is the fallout?  The stock markets have reacted poorly to the inflation news.

However, the problem is not only inflation. If sustained inflation looks possible, it is likely that the Federal Reserve will lift interest rates in an attempt to slow inflation. That move — making loans more expensive — could slow overall economic growth.

Basically, inflation makes goods and services more expensive and decreases the value of your money.

Perhaps these famous people define it best:

Inflation is when you pay fifteen dollars for a ten-dollar haircut you used to get for five dollars when you had hair.
-Sam Ewing

Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.
-Ronald Reagan

Some idea of inflation comes from seeing a youngster get his first job at a salary you dreamed of as the culmination of your career.” -Bill Vaughn

Bankers know that history is inflationary and that money is the last thing a wise man will hoard.” -William Durant

Inflation is the crabgrass in your savings.” -Robert Orben

Inflation is when sitting on your nest egg doesn’t give you anything to crow about.” -Unknown

The Fourth Edition of the American Heritage Dictionary of the English Language defines inflation as, “A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.”

When you are working – your wages generally rise as the costs of goods and services increase. Your earnings “keep pace with inflation”, so normal inflation is not generally a big concern. However, when you are living off of savings – inflation literally robs you of income.

Most people underestimate the impact inflation will have on their retirement plans. Even at relatively low rates, inflation is a real thief of buying power over time.

Most experts feel safe recommending that individuals calculate their retirement needs using a 3 percent inflation rate. But, it is important to understand that we have seen (as in the late seventies and early eighties) sustained inflation rates of around 10 percent!

So, inflation risk is a very real threat to your ability to maintain your desired quality of life in retirement.

Below are 8 ways to protect your finances:

Inflation planning should be a significant concern when crafting a retirement plan.

You should assess the health of your retirement finances at various rates of inflation.  (Don’t just trust the default values hidden in many simple retirement calculators.)

You should know what will happen to your finances if inflation rises at 2% or 10%. NewRetirement’s Retirement Planner gives you both optimistic and pessimistic controls for inflation rates. Additionally, we enable you set optimistic and pessimistic inflation values for general spending, housing and medical costs (these categories typically rise at different rates).

Try different scenarios to see if your quality of life is safe at different inflation levels.

You need your retirement plan to be solid no matter what happens.  So, you may need to be prepared to adjust spending and your investment portfolios if inflation goes up at your predicted pessimistic levels or worse.

Furthermore, be prepared for a shift in expected returns on your investments as inflation puts pressure on other economic metrics like interest rates.

Real estate and commodities are investments that have intrinsic value and typically grow in financial worth during inflationary periods.

Explore 8 ways to invest in real estate for retirement.

Traditionally, owning a house and using debt (a mortgage) has been a great way to build wealth and hedge against inflation, since you:

  • Have the hard asset – the house
  • Are using debt to finance part of the house. In recent history, inflation has helped make paying that debt off easier (assuming you are working and converting your human capital into dollars)

You have probably heard that the older you get, the less risky your investments should be.  While this is absolutely true, you do also need your savings growth to keep pace with inflation. For example, if you are getting an 8% return on your investments, but inflation is at 3%, then you are only actually earning 5% on your money.

Investments in stocks are typically the best way to keep up.  Treasury Inflation-Protected Securities (TIPS), inflation protected bond funds, floating rate funds and dividend paying stock index funds are other options.

Your retirement portfolio should be carefully crafted to give you both the:

  • Growth you need so that the buying power of your assets keep up with an inflationary economy
  • Peace of mind that you won’t lose the money you need to spend

Want help with your inflation and investment strategy?  NewRetirement offers an advisory service through a subsidiary called NewRetirement Advisors. You can get financial advice and guidance from a certified financial advisor (CFP) who will work with you and use the NewRetirement Retirement Planner and PlannerPlus to help you manage and achieve a secure future. You can learn more here.

If there is a difference between your guaranteed lifetime income (Social Security and pensions) and your necessary expenses, you should consider ways to close that gap.  Lifetime annuities are one way to guarantee your income, just make sure you buy an annuity that includes inflation protection.

If inflation goes up, wages usually also go up. So, work can be an excellent cure to inflation woes.

Here are a few resources to explore if a retirement job is of interest:

There is no way to know what is going to happen with inflation, interest rates, the financial markets, your health and more. And, while you can not see THE future, you can take a peak into multiple possible futures by running different scenarios with your financial plans.

This is a great way to build confidence in your ability to fund the future you want to have.

Use the NewRetirement Planner to try different possible economic situations and how you can counter balance negative consequences.

Try out:

  • A part time job during a high inflation period
  • Reducing expenses if investment returns are lower than expected
  • Buying a lifetime annuity. What is the  impact your net worth now and your estate value in the future?
  • Shifting investments (and possible rates of return)
  • And more…

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