Inflation and Your Retirement

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If you have paid attention at all during the last 12 months, you surely have heard the word inflation come up on more than one occasion. And as inflation is double what it has been for most of the last 10 years, it’s not surprising that it’s such a popular topic of conversation.

During uncertain times such as these, it’s easy to worry about your future. How can a prolonged inflationary period affect retirement? How can you mitigate the effect of rising inflation? What are some common misconceptions that may have held true in the past, but are no longer relevant?

The Facts

Inflation has averaged about 3.9% over the last 50 years, with the last 10 years hovering below 3% until just recently. Inflation will likely moderate over the coming months and years, but is likely to stay above the Fed’s 2% target.

What has caused inflation recently?

The high inflationary environment we’ve seen over the last 12 months has been a product of a few different factors in particular: Stimulus funds, supply shortages, and, most recently, tensions in Ukraine. The common denominator throughout this entire inflationary period, however, has been stimulus funds. When there are more dollars chasing fewer products, prices go up, which is what we have seen over the last 12 months. Experts have argued that the inflation we’ve seen is transitory and is related to coming out of the Covid-19 pandemic.

Inflation can be the silent killer

When you look at inflation over a short period of time, it can be challenging to see its impact. For example, if inflation is around 3% and you want to buy a $100 item, in 12 months, that item might be $103. A $3 difference is unlikely to prevent you from buying that item, however, over time that 3% interest may just be the silent killer. Let’s take that same $100 item, but say that over the course of about 20 years it doubles in price. If all of your expenses were to double in price over 20 years, it would make a huge difference. For example, someone who retired at age 60 needing $50,000 a year would then need around $100,000 a year by age 80. You can begin to see how that 3% that seemed small and insignificant over a 12-month period could actually be a serious oversight if neglected.

For retirees that largely are on a fixed income, this can be especially concerning. Social Security does have a cost-of-living adjustment (COLA), which was 5.9% for 2022, but it is well known that the Social Security trust fund is underfunded and, at its current rate, experts estimate they will have to reduce payments at some point in the next 10 to 15 years. There are several solutions to extend the life of the Social Security trust fund, one of which could be reducing or eliminating the COLA. The intention of Social Security payments is to replace about 40% of someone’s retirement income. This raises the question: How can a retiree better hedge against inflation?

What you can do?

The short answer is to have investments that outperform inflation overtime, but there are a couple common misconceptions here, as well as some past solutions that may not be viable options today.

One of those misconceptions is that gold is a good inflation hedge. While gold can be an inflation hedge, over long periods of time it is not nearly as good of an option as investing in a diversified stock mix. As of 4/5/2022 the 1-year return of a common gold ETF, GLD, was 10.7%, compared to the Vanguard SP 500, VOO, which was 12.54%. While not dramatically different, if you look at 10-year returns, that gap widens to 1.25% for GLD and 14.69% for VOO.

A common strategy over the last 30 years while interest rates have been falling is to weight more and more of your investment portfolio towards bonds as you get closer to retirement age. That mostly worked well when interest rates were higher and a bond yield could get you between 5% and 7% annually, but the environment that we are in today has yields in about the 2% to 4% range, just keeping pace with inflation. The objective of somebody moving funds towards bonds should still be the same: to de-risk their portfolio. However, if you’re trying to better hedge against inflation one might have to increase the risk profile to get some of the same returns that they’ve gotten with a more bond heavy portfolio in the past.

For individuals saving for retirement, you can hedge inflation by allocating your portfolio to diversified stock portfolios, in addition to inflating your contributions each year. As an example, if you contributed $10,000 in one year and you wanted to adjust that for inflation, you might contribute $10,300 the next year. Often times we will see clients max out their IRAs and/or 401(k)s. Typically the contribution limits increase every couple of years, so if you’re always maxing those out you may have a semi built in inflation adjustment, but it is worth double checking that your savings rate is in line with your objectives.

In conclusion, inflation is an extremely important concept that is much more significant than it may appear to be on the surface, and if you do not plan for it, it can severely alter your financial outlook.

Do not hesitate to contact us to learn about who we are and how we can help protect your investments over time.

Matthew Benson, CFP®

Owner / Certified Financial Planner™

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Important Disclosure

Advisory services are offered through Sonmore Financial LLC, an Investment Advisor in the State of Arizona.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.

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