Retirement and Inflation

Retirement has a number of different complexities to it that make it challenging for many people to navigate. One of the biggest topics in the news lately has been the conversation around inflation

Since the onset of Covid, Uncle Sam has poured over $5 trillion and counting into the economy, which is just about the size of Japan’s GDP. That along with the impending reopening of the economy and pent-up demand has some economist worried that inflation will be a major issue moving forward. So, the real question is whether or not this something you should be worried about when planning for your retirement. Before we jump into that, let us take a step back so we can truly understand what inflation is.

What Is Inflation

Inflation occurs when prices rise, decreasing the purchasing power of your dollars. For example, in 1985 the average sales price of houses sold was about $100,000 compared to over $390K in the 4th quarter of 2020.1 I have always heard people use the price of a stamp as a gauge of inflation.

Inflation does not refer to just one item that is getting more expensive, it is referring to a broad basket of items people typically consume or buy. The most common measure of inflation in the US is the Consumer Price Index or CPI. This measures the average change in prices paid by consumers for things like food, clothes, housing etc. The Social Security Administration uses an index called CPI-W, which is price increases for urban wage earners and clerical workers, to calculate cost-of-living changes to apply to social security benefits. A lot of retirees I speak to believe that inflation is a bad thing.

Though it can be frustrating to think about your dollars losing value due to inflation, most economists consider a small amount of inflation a sign of a healthy economy. Inflation is a whole lot better than Deflation. Prices going down might sound like a good thing on the surface, however deflation slows economic growth. As prices fall, people hold off on purchases in hopes of getting a better deal. And it is that mentality and action that leads to less demand for goods and services which leads to less workers needed at companies to service demands, which leads to layoffs and now those people do not have the money to spend which drops prices further. It is a downward spiral which is what turned the 1929 recession into the Great Depression.

A moderate inflation rate encourages you to spend or invest your money today, rather than stuff it under your mattress and watch its value diminish. Just as deflation can damage an economy, so can in Inflation when it is allowed to get out of hand and rise dramatically. Unchecked inflation can wreak havoc on a country’s economy, like in 2018 when Venezuela’s inflation rate hit over 10,000,000%,2 causing the economy to collapse and forcing countless citizens to flee the country. As the currency became worthless, some companies started offering bonuses paid in eggs3.

Causes Of Inflation

So, what actually causes inflation? There are 2 main causes of inflation, Demand-pull, and Cost-push. Demand-pull occurs when demand from consumers pull prices up. When there is more demand than supply and producers can’t make enough to meet demand. As some would say, too much money chasing too few goods. Over-expansion of the money supply can also create demand-pull inflation. So when the government prints too much money, the money supply expands, it lowers the value of the dollar. When the dollar declines relative to the value of foreign currencies, the prices of imports rise which increases prices in the general economy.

The second cause of inflation is cost-push inflation. This occurs when the supply of a good or service changes, but the demand stays the same. prices are pushed up by increases in the cost of production such as labor, capital, and land or the price of raw materials. there is a supply shortage combined with enough demand to allow producers to raise prices. We are seeing this happen right now with the cost of lumber. The pandemic caused the shutdown of lumber production and with people spending more time at their home, the amount of home renovation projects has skyrocketed causing the price of lumber to increase over 250%. I have a 2 year old and a 4 year old, so the thought of building a sound proof bunker to get some quite work done crossed my mind a time or two during the lockdowns.

How Does Inflation Affect My Retirement Plan?

The inflation rate affects how much your retirement dollars will really be worth. Over time, it can make a significant impact to the purchasing power of your assets. Understanding how inflation may hurt your retirement strategy is extremely important for ensuring that you have enough assets to last through your later years. The last thing you should be doing when you are in your late 70s or 80s is looking up resume templates because you didn’t plan properly for the impact of inflation.

Historically, inflation in the United States has been right around the 3% level3. But the current inflation rate, as measured by CPI was about 1.7% for the 12 months ending February 20214. For people over age 62, there is a statistic called CPI-E, the Consumer Price Index for the Elderly.

The CPI-E captures the spending of adults who are age 62 and above. Since 1982 when the CPI-E was created through 2020, it averaged 2.79%--a touch higher than CPI measurement we discussed earlier, which was about 2.60% per year, on average, over that same stretch4.

Now you might look at the CPI weightings and realize that it looks nothing like your expenses. You can get closer to a personal inflation rate by looking at your actual spending in each of the major categories and blending that with the inflation we're seeing in those areas. As you get closer to retirement, it is important to get a good idea of what you are spending and where. So, either you can have some fun doing it yourself or our firm would be happy to help you in that area. When constructing your retirement plan, it’s a good idea to model what your retirement would look like under different inflation scenarios.

For people who are in retirement there is no cost-of-living adjustment in the paycheck that they're taking out of their portfolios. Social Security will give you a little bit of a bump up to keep pace with inflation. But whatever you are pulling out of your portfolios to cover your living expenses is not inflation-adjusted in anyway which is why it will be important to make sure that you have adequate inflation hedges in your portfolio.

Inflation and Retirement Income Planning

What can you do about inflation to help protect your retirement income plan?

You could always work. I know that defeats the purpose of retirement, however 55% of workers plan to continue working, with 41% going part time5.

It will also help for you to maintain an investment discipline. Don’t try and over think investing just because people are talking about inflation. I get asked all the time, “if inflation increase should  I just buy more gold?” Gold may be one of the first asset classes that comes to mind when thinking about inflation, however historically, the best inflation adjusted returns has actually been stocks. Gold’s average five-year inflation-adjusted return since the mid-1970s is 2.2% annualized. The comparable average for the dividend-adjusted S&P 500, is 8.4%.6 I am not saying that inflation is good for the stock market, in fact going back to 1928, the stock market gained on average over 6% when inflation was rising or when inflation was above 3%. However, when inflation was either falling or was below 3%, the stock market averaged close to 16%.7 Just because stocks have given the best inflation adjusted returns, it doesn’t mean it’s going to be smooth sailing and that you want to deviate from your long-term plan.

Another thing you can do when planning for inflation in retirement is Delay Social Security. If Social Security is not your main source of retirement income and you have enough money to fund your retirement while waiting, delaying Social Security benefits can help guard against inflation. While benefits do increase for cost-of-living adjustments, delaying your benefits from full-retirement age to age 70, increases your benefit by 8% per year and your benefit is also inflation-protected. This is often one of the most commonly made retirement mistakes I run across

The most important thing you can do to fight inflation, is to plan for it. Incorporating a higher-than-normal amount of inflation in your financial plan will give you the ability to see just how successful your retirement will be if we do go through a period of high inflation. Just remember that inflation is not a consistent number, and that is why it is a good habit to consistently update your retirement plan on a regular basis. If you haven’t updated your retirement plan lately or just want to make sure that you are on track, use the link below to schedule a time for us to connect and we would be happy to help.

1- St. Louis Federal Reserve

2- International Monetary Fund

3- Reuters-  Salary + 144 eggs: Venezuelan firm offers unusual monthly compensation

4- BLS,

5- Transamerica Center for Retirement Studies- annual Transamerica retirement survey 2019

6- Marketwatch- How stocks, gold, bitcoin and tips can hedge rising inflation

7- NYU- Historical Returns on Stocks, Bonds and Bills 1928-2020

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