According to a survey conducted at the end of 2021, about 88% of Americans are very worried about inflation and many say they are planning to cut back their spending.1 Prices for consumer goods have risen more than six percent—the most significant year-over-year increase since 1990—and nearly every category of spending has been impacted.2 Although Americans are still worried about COVID19, rising inflation is now seen as the biggest risk to their retirement plans.3
Inflation over the years
According to inflationdata.com, inflation has been relatively low over the past three decades. It averaged slightly over 3% in the 1990s, 2.5% in the 2000s, and under 2% in the 2010s. Compare that to the 12 months ending November 2021, when the annual inflation rate for the United States jumped to 6.8%.4
Economists point to many factors when explaining this spike in inflation. Production difficulties from the shortage of semiconductor chips have raised concerns that bottlenecks in the supply chain could drive up input prices. Wages for workers have surged, exceeding the rate of inflation. Meanwhile, some workers have exited the labor market, either due to public health concerns, or the lack of available childcare, or other reasons.
From an investor’s perspective, higher inflation is viewed negatively for its impact upon stocks. Inflation increases borrowing costs, as well as materials and labor costs, and reduces living standards. These factors, in turn, reduce expectations of earnings growth, putting downward pressure on stock prices.
Tips to prepare for inflation in retirement
These principles help form a sound retirement strategy at any time, and especially when inflation is a bigger factor.
1. Start by maximizing Social Security benefits.
Social Security has its own financial problems, and the system will need to be reformed to remain solvent. Any changes, however, are more likely to impact younger workers. It is unlikely that those entering retirement will see changes to their benefits in the next five years. Social Security has an automatic cost-of-living adjustment built into it. Retirees should examine their plans to maximize Social Security benefits and get the most from this inflation-fighting feature.
2. Build substantial savings and keep a sufficient percentage of your assets
This is another excellent way to fight inflation in retirement. Historically, while equities have shown more volatility (larger ups and downs) than fixed income, they have fared well in relation to inflation.
Jeremy Siegel’s guide for investors, Stocks for the Long Run, which was first published in 1994 and released as a fifth edition in 2014, examines the returns of different types of assets going back to 1802. Seigel adjusts the return of each type of asset to factor out inflation and show the net return. These inflation-adjusted figures are known as “real returns.”
Siegel concluded that over 210 years, the real return of a broadly diversified stock portfolio averaged 6.5 to 7% per year. In other words, a diversified stock portfolio beat inflation by 6.5 to 7% per year. This means an individual’s purchasing power would have doubled about every decade for the past two centuries.
3. Allocate your assets to include equities, fixed income, and cash.
Siegel’s reporting does not mean all retirees’ investments should be in stocks. We suggest establishing an asset allocation strategy that allows investors to take advantage of volatility in the financial markets while minimizing the potential effect upon retirement income.
To increase the probability that at least part of your portfolio is performing well, diversify the equity portion of your allocation between growth and value stocks, domestic and foreign stocks, and small and large company stocks. Let your asset income: In years when the stock market goes up, take income from stocks; in years when the market performs poorly, take income from fixed-income assets. Just remember that diversification doesn’t ensure profit or protect against loss.
4. Monitor and control spending carefully.
This is the final key to financial security in retirement. Inflation can be detrimental to retirement finances, but carefully managing spending throughout your golden years helps counter its impact. It is best to have a financial strategy that is flexible enough to adapt to your changing needs and circumstances.
To help control spending, select a withdrawal rate that can be sustained over a long period of time. Research on sustainable withdrawal rates suggests that a 4 to 4.5% distribution can be maintained and increased yearly with inflation. We suggest a distribution rate of no more than 4% to start. While you may need to reduce the dollar amount if the rate exceeds 6% in a down market, setting the amount at 4% or below can allow for principal volatility without requiring frequent changes to the distribution.
Further, in years when the market performs poorly, consider delaying cost-of-living increases. We often recommend holding off on large purchases such as a car replacement until a good market provides excess earnings.
The future is uncertain, and those planning for retirement are right to be concerned about inflation. Planning helps prepare for uncertainty. Seeking the advice of a competent retirement planner can help you gain confidence in your plan.
- A recent study reported many Americans believe inflation is the biggest risk to their retirement plans.
- Social Security has an automatic cost-of-living adjustment built into the benefit.
- According to Jeremy Siegel’s research, a diversified stock portfolio beat inflation by 6.5 to 7% per year over the past 210 years.
Originally Posted on January 4, 2017
- 88% of Americans Are Worried About Inflation. By Lorie Konish, CNBC November 23, 2021.
- Source: Bureau of Labor Statistics.
- Rising Inflation Seen as Biggest Risk to Americans’ Retirement Plans in 2022. Survey conducted by Allianz Life Insurance Company of North America. December 13, 2021.
- Source: usinflationcalculator.com.