How do I inflation proof my retirement?
Think back to how much a loaf of bread or carton of milk cost when you were younger compared to what it costs today.
Over time, small price increases can add up.
A dollar today would be worth roughly half of what it was 25 years ago at an average inflation rate of 2.5%.
Protecting the purchasing power of your money is key to maintaining your lifestyle in retirement.
Why does inflation matter in retirement?
Inflation measures the change in the cost of living over time. There’s a good chance the spending power of the income you have now will be reduced by inflation during your retirement because the costs of goods and services will rise.
Part of maintaining your lifestyle in retirement is making sure your retirement income can keep up with inflation.
Even low rates of inflation can have a large impact on your purchasing power
Even low inflation rates can have a large impact on purchasing power if the time period is long enough. For example, if inflation averages 2.5% per annum, then after 15 years, 31% of the real value of each dollar of retirement savings has been lost and by year 28, half the real value is gone.
The chart below shows the falling value of $100 over a 30-year period.
Managing the risk of inflation – what are the options?
Our Retirement Financial Advisors have considered the six things to consider to support you in managing the risk of inflation for your retirement savings:
Avoid holding too much cash
Everyone needs to have some money in savings accounts to pay for everyday expenses, save for emergencies and plan for large purchases.
However, as a long-term investment, cash is not where you want to be, especially when the economy is experiencing high levels of inflation.
As inflation takes its toll, you’re able to purchase fewer goods and services each year with your cash.
If you’re holding more cash than you need, consider investing some of it in long term investments that are more likely to maintain your purchasing power over time. Experts suggest holding about 3 to 6 months worth of expenses in an emergency fund, but if you have more than that saved, in the long term, you may likely be better off if you invest it.
Re-evaluate your portfolio
This is an opportune time to revisit your portfolio and asset allocation with your Lake Macquarie Financial Planner to see if they still meet your desired rate of return and risk tolerance. A couple things to keep in mind related to stocks and bonds in a higher inflationary environment:
Stocks offer higher potential returns, which can help your portfolio outpace the rate of inflation, but stocks also tend to be more volatile than conservative investments like bonds.
Bond prices maintain an inverse relationship with interest rates. One of the Federal Reserve‘s tools to combat rising inflation is raising interest rates, and when interest rates rise, bond prices typically decrease. As a result, you may want to avoid overexposure to bonds, which may tumble in value during a rising-rate environment.
Explore physical assets
Real estate investments tend to do well during inflationary environments because, as inflation rises, landlords are able to pass those higher costs on to their tenants. However, within Australia we have other factors that are affecting the property market which need to be taken into consideration.
Other real assets to consider include infrastructure where agreements for airports, toll roads, ports, water and electricity have revenue linked to inflation.
Consider commodities
While stocks and bonds tend to perform better when inflation is low, commodity prices tend to rise with inflation. For that reason, investing in commodities can be an appealing hedge against inflation.
Look into inflation linked investments
There are investment products that are designed so that their principal value is indexed to the rate of inflation. When inflation rises, the value of the principal is adjusted up and the interest rate, or coupon, also rises. When inflation falls, principal value is adjusted down and coupon payments will decline as well.
Revisit your budget
Inflation can be particularly hard on investors who are nearing, or who have just entered, retirement. Drawing down your investments faster than planned at the beginning of retirement can have long lasting-effects on your savings for years to come. To help avoid this, look for areas in your budget where you can cut some discretionary expenses, at least in the short-term. Putting off that trip to Europe or caravan trip around Australia for a year or two could pay dividends for you down the road.
Sources:
https://www.challenger.com.au/personal/retirement/could-i-outlive-my-savings/impact-of-inflation
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