Retire Without Worry: Plan for Inflation
After years of U.S. leaders often worrying about not enough inflation, the conversation has flipped. In 2021, inflation climbed to the highest rate in almost 40 years, according to Bloomberg. Whether this is the first time in your adult life you’ve experienced inflation like this, or recent events have triggered memories of high-inflation periods like the 1970s, it’s natural to wonder what inflation’s climb means for your retirement.
Inflation in retirement can cause your purchasing power to shrink, making it harder to live the lifestyle you planned. While some inflation is expected—the Federal Reserve has a long-term target of 2% annual inflation—the challenge is when inflation rises too high for too long.
If that happens, the money you saved for retirement might not last as long as you anticipated. That’s not to say that inflation in retirement is a cause for panic, but it is a call to take steps to limit the impact.
Invest with Inflation in Mind
One way to protect yourself in retirement, and leading up to it, is to invest with inflation in mind. Some fixed-income assets, for instance, provide hedges against high inflation. For example, Treasury inflation-protected securities (TIPS) are government bonds that keep pace with inflation via the Consumer Price Index (CPI).
The yield on TIPS might not be very high, especially in periods of no or low inflation. It’s a good idea to have other bonds, such as high-quality shorter-term bonds, in the mix as well. Consider talking with a financial advisor to determine an allocation based on your needs and goals.
Diversify Investments
Another approach to inflation protection is to make sure your portfolio is diversified. That way, even if inflation surges, you may hold some investments that lessen the blow—especially when inflation affects certain sectors more than others.
Some people feel like they should hold their money in cash rather than invest it. Effectively, the value of your cash drops as inflation rises, and your bank account is unlikely to give you an interest rate that offsets inflation.
Historically, the stock market has returned about 10%. Although history provides no guarantee for future returns, stocks in a diversified portfolio can provide an opportunity to counter inflation’s impact.
Leverage Social Security
Another way to hedge against inflation in retirement is to leverage the inflation protection built into Social Security payments. Social Security benefits can increase due to cost-of-living adjustments based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). In December 2021, Social Security benefits increased by 5.9% due to these cost-of-living adjustments.
You might decide to postpone collecting Social Security benefits to allow your baseline benefit to grow, making each inflation adjustment more valuable. For example, a $1,000 monthly benefit that increases by 5.9% would equal a $59-per-month raise. Yet a 5.9% adjustment on a $700 monthly benefit would equate to only a $41.30 increase.
Overestimate Your Nest Egg
Since inflation can be hard to predict, you might want to add a buffer by overestimating the nest egg you need to retire comfortably. Perhaps you can save an extra percentage point or two of your salary each year to grow your retirement savings beyond the level where inflation would force you to adjust your lifestyle.
If it turns out that inflation doesn’t affect you greatly, you may still feel grateful that you overestimated given other factors—for example, your investment returns end up lower than anticipated. A low inflation environment can mean low interest rates, so your fixed-income investments might not provide as much retirement income as you planned.
Thus, having a bigger nest egg could help. And if you end up with more than you need, that money could be used to fund your big-ticket dreams or passed on to heirs or charity after you pass.
Prepare Your Finances
Although inflation can be challenging, that doesn’t mean you need to fear its effects. With proper planning, you can position your finances to help hedge against inflation for a comfortable retirement.
Speaking with a CERTIFIED FINANCIAL PLANNER™ (CFP®) professional can help you plan for inflation based on your specific circumstances. Our Greenwood Village, CO, fiduciary financial advisory firm offers a complimentary 15-minute call to discuss your concerns and share how we may be able to help.
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