How To Plan For Retirement During Inflation
So is inflation just another of life’s constants, or is it a momentary spike that eventually tapers off? Or is it both? Let’s take a look at what inflation is, how it can affect your retirement, and what you can do about it.
How Long Does Inflation Stick Around?
If you’ve ever heard your grandparents talk about how a loaf of bread once cost a dime or how they made $28 a week working at a factory, you have an idea of how prices rise over time and how wages usually rise with them. Looking at 2022 prices, your loaf of bread now costs $2.50 and the average weekly wage is $1,205.
While wages and prices both rise, they don’t always rise at the same rate, and it’s often prices that rise faster. When prices spike, that’s when people often focus on the inflation that has always been there.
Certain economic factors can make the cost of living rise even more acutely than usual for people. The ongoing pandemic, as well as war overseas and its effect on energy prices, are among these factors. This is a big concern for current and future retirees because many will likely be retired for several decades. No one likes the idea of the purchasing power of their money declining for an extended period.
Hedges Against Inflation
The good news is that our economy has two things that are reasonably good hedges against inflation: real estate and the stock market.
Real estate as rental income can provide a steady stream of money that can take the burden off a fixed retirement income. By downsizing, you can monetize the house you’ve always lived in by selling it for more than you paid for it.
While the stock market doesn’t always outpace inflation, investing in stocks has historically provided higher returns than other asset classes. A balanced portfolio usually features a mixture of both growth and value stocks:
- Growth stocks: often perform well when inflation is low. When investors put money into growth stocks, the hope is they may earn money through capital gains when they sell shares in the future.
- Value stocks: perform particularly well during periods of high inflation. Value stocks are good for long-term investors, as they often pay dividends.
Fixed vs. Adjustable Income
It’s important to know which parts of your income remain fixed and which parts adjust for inflation. Your retirement savings contained in an IRA, 401(k), or savings account is a fixed amount of money. The value of that finite pile of money is subject to inflation’s whim.
If you have a pension, you do have a continuous stream of money coming in every month, so it’s not finite in the sense that it replenishes itself every month. But if inflation goes up, the payment amount typically does not adjust.
While Social Security does not generally make up the bulk of a person’s retirement savings, the payments are continuous, and they are periodically adjusted for inflation.
How to Account for Inflation Before You Retire
The sooner you get hedges against inflation in place, the more effectively they can work for you. The first step is to identify your sources of retirement income that won’t keep pace.
Then you can calculate the total amount of your nest egg and, by using an inflation calculator, you can estimate its worth in 10, 20, and 30 years. For example, $100,000 at 3% annual inflation would be worth $55,367 in 20 years.
You would need to save $180,600 to have the same purchasing power that $100,000 has now. Using this information, you can consider changes to your portfolio that would help account for that shortfall.
You Can Reduce Inflation’s Impact
By revisiting your investment strategy, you can take steps to reduce the negative impact inflation could have on your retirement savings. When thinking about how to use your retirement savings, it’s important to factor in the impact of inflation on daily-basis goods, like groceries, and services, like healthcare. Working with a professional financial advisor on a detailed investment plan can help ensure your portfolio keeps pace with rising costs and lasts throughout your retirement.
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