INFLATION CITY

Most retirees need both a portfolio safety for the purpose of stability, and asset growth for sustainability. One can argue whether stability or sustainability is the most important aspect. However, we feel it is now most important to focus on the number one threat to both portfolio stability and sustainability, namely… Inflation.

Inflation refers to the general increase in the cost of goods and services over time. Before discussing how inflation can impact a retiree’s portfolio, let’s note a few inflation myths:

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Inflation Myths:

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1) An increase in the money supply is the cause of inflation.

Actually, inflation is influenced by a complex mix of economic and social factors and not the result of just one specific cause. Other factors that can contribute to inflation include supply and demand imbalances; changes in production costs such as wage increases; changes in government policies; and global events such as war or natural disasters.

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2) Inflation is always bad for the economy.

Yes, high inflation can be harmful.  It reduces the purchasing power of money, and can potentially result in business uncertainty and economic instability.  On the other hand, moderate inflation can be beneficial. It can encourage spending and investment.

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3) Inflation affects all goods and services equally.

Actually, prices for some goods and services may rise more quickly than others.  For example, healthcare costs and house/rent prices often rise more rapidly than other costs during times of high inflation.

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‍4) Inflation can be cured by just tightening the money supply.

Just as the rise in inflation is not the result of one cause, its cure is not dependent on one strategy. Having less money in the economy can help to reduce inflation, but it is not always the most effective solution.  It may be better to address the underlying causes such as supply chain issues or structural imbalances in the economy.

High inflation negatively impacts retirees.

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Even though we can identify the myths about inflation, the simple fact remains that high inflation can, and often does, have a negative impact on retirees in a number of ways.

High inflation reduces purchasing power.

Inflation erodes the purchasing power of a retiree’s portfolio.  Consider that a retiree usually lives on a fixed income typically provided by Social Security, and additional savings which may be contained in a certificate of deposit, savings account, money market fund, 401K, equities, etc.  Those savings are essentially storing purchasing power to be used later.  As a retiree, you expect that you will be able to use that power to purchase goods and services in the future. However, if the rate of inflation is higher than the rate of interest you are earning on your savings, the purchasing power of your savings decreases over time which makes it difficult to keep up with rising prices.

An example will help illustrate this. Let's say you have $50,000 of purchasing power in a savings account at the start of the year which will cover the cost of the items you depend on through the year. The rate of interest on the account increases the purchasing power of the savings by 2% to $51,000. However, during the year the total cost of your needed goods and services rises by 10% to $55,000. Obviously, you will fall $4,000 short in your ability to buy what you need during the year.

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High inflation increases the cost of living.

As the example above shows, the inflated cost of goods and services makes meeting basic needs, such as housing, food, etc, more challenging. This can be particularly taxing for those retirees who have limited savings, and are completely reliant on their fixed income to cover their expenses.

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High inflation increases healthcare costs.

Healthcare costs typically tend to increase at a faster rate than inflation.  This can be especially demanding for retirees who may require more healthcare services as they age. This can result in retirees paying a larger portion of their fixed income for healthcare needs. Consequently, that may reduce their ability to afford other necessities.

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High inflation has the potential to reduce the value of assets.

Inflation’s impact can reduce a retiree’s overall net worth by reducing the value of equities, for example, thereby limiting the ability to generate income from those investments.

Overall, high inflation presents significant challenges for retirees, especially those living on a fixed income, since they may not have the ability to increase their income or adjust their expenses to keep up with rising prices.  It is important for retirees to plan for inflation as part of their overall retirement planning to help mitigate its impact on their financial well-being.

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Planning for inflation is part of retirement planning.

Retirees can, and should, plan for inflation as part of their overall retirement planning.  Following are some steps to take.

Consider the impact of inflation.

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Retirees need to consider the impact of inflation on their retirement savings. It isworth while factoring in an annual inflation rate of around 3% when estimating future expenses since it is the historical average. Obviously that percentage will need to be increased during a period of high inflation, as the one we are currently in.

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Estimate retirement expenses.

Retirees should estimate expenses during retirement, including their essential expenses like housing, healthcare, and food. Discretionary expenses, like travel and entertainment, can also be estimated especially if these are important quality of life items. This will help them understand how much they need to save to maintain their standard of living.

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Invest in inflation-protected securities.

An effective way to protect hard earned savings against inflation is to invest in securities that offer protection against inflation. Some examples of such securities include TIPS (Treasury Inflation-Protected Securities), I-Bonds(Inflation-Indexed Savings Bonds), and inflation-linked annuities.

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Diversify investments.

Diversifying an investment portfolio can help to reduce the impact of inflation. By investing in a variety of asset classes, including stocks, bonds, real estate, etc, retirees can spread their risk and potentially earn higher returns. Of course, portfolio diversification requires having funds to spread around. Hence, it is not a strategy that all retirees can take advantage of.

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Adjust expenses.

Cutting down on unnecessary expenses can reduce the impact of inflation. This may be necessary for retirees who have reduced savings and depend heavily on their fixed income, like Social Security. Adjusting expenses could include downsizing living arrangements, reducing travel, and finding ways to reduce shopping and utility bills.

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Consider taking on a part-time job.

Retirees can supplement their income by taking on part-time work. This can provide additional income to help cover rising costs and offset the impact of inflation.

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Monitor spending.

Retirees should monitor their spending and adjust their budgets as needed to accommodate rising prices. They should also be mindful of their savings and investments, making sure they are earning a competitive rate of return and not losing significant purchasing power due to inflation.

By taking these steps, retirees can plan for inflation as part of their overall retirement planning and help ensure that they have enough savings to support themselves throughout their retirement.