There are many unknowns when it comes to planning for retirement. Tax laws are continually in flux, healthcare costs are on the rise, and financial markets are unpredictable. Yet among the multitude of uncertainties lies an ever-present, invisible force that can spoil your retirement plans if you ignore it: inflation.
Indeed, inflation can chip away at your retirement savings over time, reducing the value of your hard-earned dollars when you need them most. Fortunately, a well-crafted retirement plan can offset the impact of inflation, so your nest egg lasts throughout your golden years.
With the right financial planning and guidance, it’s possible to safeguard your financial future against the rising tide of inflation. In this article, we’ll explore what inflation is, why it matters for current and future retirees, and, most importantly, what you can do about it.
What Is Inflation?
Simply put, inflation is the rate at which the prices of goods and services increase over time. As inflation rises, your dollars lose purchasing power. That’s why everyday items seem so much more expensive today than they were just a few years ago.
The Bureau of Labor Statistics publishes the Consumer Price Index (CPI), which is the most popular measure of inflation in the United States. While CPI has its drawbacks, it provides a useful benchmark for understanding how prices rise over time.
For example, from the beginning of 1960 through the end of 2022, the average annual inflation rate in the United States was 3.8%. To put this rate in perspective, an item that cost $100 in 1960 cost just over $1,000 at the beginning of 2023.
Meanwhile, prices have nearly doubled over the last 30 years due to inflation, according to WorldData.info. Thus, holding all else equal, any money you put in savings 30 years ago is worth about half as much today.
Of course, these are simplistic examples. Nevertheless, they illustrate how inflation can significantly erode the value of your retirement savings in the absence of proper planning.
The Impact of Inflation on Retirees
As inflation increases the cost of living, the same amount of money covers fewer expenses. And since many retirees live on a fixed income, inflation can be particularly problematic later in life.
This is true for three reasons:
- People are living longer than in the past. According to the Social Security Administration, a man reaching age 65 today can expect to live, on average, another 18 years. Meanwhile, women turning 65 can expect to live another 21 years, on average. That means the average retiree’s retirement savings must last them at least 20 years.
- Healthcare costs are increasing faster than the average inflation rate. Since 2000, healthcare expenses have increased by 115.1%. In contrast, prices for all consumer goods and services increased by 78.2% over the same period. For many retirees, healthcare is one of the biggest expenses in retirement, and inflation only makes it more challenging to keep up with these costs.
- Most retirees can’t rely on Social Security and Medicare to cover retirement expenses. Although the Social Security Administration periodically adjusts retirement benefits for inflation, most retirees will need supplemental sources of income to cover their living expenses. Most of the time, this additional income comes from savings and investment accounts, which don’t automatically adjust for inflation.
The bottom line is inflation is a risk that current and future retirees can’t afford to ignore. The good news is there are several strategies that can help you protect your savings against the rising cost of living.
Consider the following tips to protect your retirement savings from inflation risk:
#1: Avoid Holding Too Much Cash
Keeping large amounts of cash in checking or savings accounts might seem like a safe bet—particularly when markets are volatile. But over time, inflation can erode the purchasing power of your cash savings, making your dollars less valuable in retirement.
You may be able to find a high-yield savings account that pays an attractive interest rate, especially when rates are on the rise. Yet cash savings typically don’t earn enough interest to keep pace with inflation over longer periods.
It’s important to keep enough cash on hand for emergencies and unexpected expenses. However, make sure you’re not underinvesting as a result. It’s crucial to balance your immediate liquidity needs with your long-term financial goals when planning for retirement.
#2: Invest in Stocks and Other Growth-Oriented Assets to Outpace Inflation in Retirement
Historically, one of the most effective ways to outpace inflation has been investing in the stock market. That’s because equities tend to provide higher returns than other investment options over the long term.
For example, the average annual return of the S&P 500 over the last 30 years was 9.8%, assuming all dividends were reinvested. When adjusted for inflation, the net average annual return was 7.1%. Meanwhile, the long-term average annual return for bonds is between 4% and 6% before inflation.
Indeed, stocks come with more risk compared to other investment types. However, a balanced and diversified portfolio can provide the growth most retirement savers need to combat inflation.
It’s important to note that as you approach retirement, your risk tolerance typically decreases. Thus, it’s crucial to periodically review your investment portfolio to ensure it remains aligned with your financial goals and time horizon.
#3: Consider Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds that adjust with inflation, making them an effective hedge against rising prices. The principal value of TIPS increases with inflation as measured by CPI, ensuring that the real value of your investment doesn’t erode over time.
As such, TIPS offer a reliable way to maintain your purchasing power in the face of inflation. But although TIPS can provide safety, their return rates are generally lower compared to riskier assets.
Therefore, while TIPS may be a key component of an inflation-fighting portfolio, they shouldn’t be your only investment. Be sure to work with a financial professional to create and maintain a suitable and well-diversified investment portfolio over time.
#4: Delay Social Security Benefits
If you can afford to wait, delaying your Social Security benefits can result in higher monthly payments down the road.
Your Social Security benefits increase by a certain percentage if you delay retirement beyond your full retirement age (FRA). Waiting until age 70 to claim your Social Security benefits maximizes your monthly payment.
Of course, this option may not be feasible if you need immediate income in your early retirement years. On the other hand, delaying your benefits can provide a helpful tailwind when it comes to offsetting the effects of inflation.
Chladek Wealth Management Can Help You Manage Inflation in Retirement
Inflation can make securing your financial future more challenging. But with the right financial planning and guidance, it doesn’t have to put a damper on your retirement years.
The above tips and strategies can help ensure your savings maintain their value throughout your golden years. However, a fee-only financial planner like Chladek Wealth Management can help you develop a personalized retirement plan that considers your unique financial needs and goals.
To learn more about how we can help you secure your financial future, please schedule your Free Financial Assessment.