Inflation - Friend or Foe to Your Retirement Plans?

Retirees are often aware of the detrimental effects of inflation on their retirement savings. As the cost of goods rises, the value and buying power of many retirement accounts diminish. And for some retirees, maintaining their savings and lifestyle becomes a challenge. 

Luckily, there are different methods retirees can use to adjust for inflation and help protect the value of their retirement. Below we discuss some of the ways inflation affects retirement and how you can prepare. 

How Is Yearly Inflation Calculated?

Inflation is calculated using the Consumer Price Index (CPI) which calculates inflation across major categories before determining a yearly inflation rate expressed as a percentage.¹ 

On average, the U.S. experiences an annual inflation rate of roughly three percent.² This percentage and the percentage expressed by the CPI are helpful for understanding inflation across multiple markets. But these values should also be understood as a general approach, meaning the real impact of inflation will depend on the individual.

For example, we might assume that a retiree might need to withdraw an additional three percent from their savings each year in order to adjust for inflation. But this isn’t the whole picture. Instead, this retiree should consider the specific ways that inflation affects them. 

Considering Individual Costs

Inflation affects each of us differently. For example, the rising cost of gasoline would affect someone that drives long distances more than someone without a vehicle. 

Retirement acts in a similar fashion, as it creates a lifestyle change that causes inflation to affect retirees differently. 

One of the better ways to measure this difference is through the Consumer Price Index for the Elderly (CPI-E), which shows inflation rates for households with individuals age 62 and above.³     

However, this is still a generalization, though of a specific population. The best way to determine the cost of inflation is to examine your personal lifestyle and make adjustments.

Managing the Effects of Inflation

With the above in mind, here are some ways to help offset inflation during retirement.

Social Security

The Social Security Administration provides the Cost-of-Living-Adjustment (COLA) to offset some of the effects of inflation by raising Social Security benefits.⁴ This can be an important source of income during retirement. 

However, the COLA is based on the CPI-W (urban workers) meaning some individuals may not be able to rely on adjustments from Social Security to make up for all cost increases.⁴

Investments that Adjust with Inflation

Certain investments can adjust with inflation -for example, high quality large cap stock or stock funds, public real estate investment trusts (REITs) or private core real estate, and commodities.  On the fixed income or bond side, inflation-protected securities issued by the U.S. Treasury (TIPs), as well asI I-bonds, are specifically constructed to adjust their returns to the current inflation rate.  Otherwise, it's important to keep your bond duration (interest rate sensitivity) short in a rising inflation rate environment. 

However, any investment comes with risk, something that should always be considered during retirement.  If you have a retirement plan in place, it's important to assess if you need to reposition your portfolio to be more inflation-friendly. Before making any changes, however, it's important that you consult with your financial advisor/planner to make sure that any changes will be beneficial in the long run.  

A Change in Lifestyle

Consider your retirement goals and overall lifestyle. Is there something you can trim back on to save on the cost of inflation? This does not mean you need to give up on retirement goals. Rather, what can be adjusted to help you achieve them while maintaining your savings?

This is by no means a comprehensive list of ways to protect your retirement savings against inflation. Rather, it is intended to demonstrate some of the options available to you. Consult with your financial advisor/planner to acquire a better understanding of how inflation will affect you, and what you can do to help protect your retirement savings.