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Sam Ewing had a great quote:
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.”
If you buried your cash in your back yard and dug it up 10 years later, inflation would have caused it to be worth less. It’s like a loss on your money, even though the actual dollar amount stayed the same.
This is called loss of purchasing power. The $10 haircut went up to $15. But it’s still just a haircut. Now the purchasing power of $10 is not enough to buy the haircut.
Inflation has a big effect on retirees. What can they do about it? Let’s look at some options.
Inflation in retirement – How big a threat is it really?
As of writing this article (2016), inflation has been rather modest for the past few years. That’s a good thing for retirees. Especially when you consider that interest rates are so low.
But long-term averages for inflation are a little over 3%. Over time this can have a big impact.
The Bureau of Labor Statistics has a simple calculator to show what a dollar in the past is worth today.
In 2012, $1 could buy what it would now take in 2016 $1.05.
That’s not so bad. But if you take it out over a 20 year period you can start to see the problem.
Over a 20 year period purchasing power fell by about 50%.
Think a moment: Can retirement last over 20 years?
Absolutely. And even longer in some cases.
Inflation in retirement – How to beat it?
Since inflation decreases the purchasing power of your money, it’s very similar to having an investment that always goes down a little each year. Nobody wants that.
But there’s no escaping the reality of inflation in our current environment. Even when it has been very modest lately.
The only way to beat inflation is to stay ahead of it. Growth on your earnings and/or income sources needs to at least keep pace with it.
Using Social Security to keep up with inflation
On the retirement income side, Social Security is one income stream that has a cost of living adjustment. The cost of living adjustment is applied to it based on the level of inflation in the economy. This helps retirees maintain purchasing power.
One strategy to keep up with inflation involves maximizing your Social Security paycheck by delaying it. Delaying up to age 70 makes your check bigger. And when there is a cost of living adjustment applied to it, you will have a bigger nominal increase, compared to a Social Security paycheck that was initiated at age 62.
Working to keep up with inflation
Another strategy is to continue to work. Typically workers will get raises that at least keep up with inflation over the long term.
This doesn’t mean you never get to retire. You may be comfortable working part time. Or perhaps even working on a contract basis. It’s just another option you may want to consider.
Investing to keep up with inflation
Another strategy to beat (or keep up with inflation) is to invest your money in such a way that the return is greater than inflation.
Most retirees will do this through their investment portfolio. Over the long-term the stock market has outpaced inflation. But there are other ways too.
For example, if you don’t mind being a landlord you could own rental property. You should be able to increase your rents to keep up with inflation over time. And the value of the house should also appreciate, all other things being equal.
Another example is through investing in a business you own. Whatever services you provide, you may be able to increase the price of them over time to keep pace with inflation.
But when it comes to investing, make sure you are not taking on more risk than you feel comfortable with. It’s hard to stick with an investment plan when you are worried every time your portfolio value falls in the market.
And if you can’t stick with the plan there is a huge likelihood that you will sabotage your portfolio by selling out after a big decline, only to get reinvested after missing a lot of growth in the meantime.
With interest rates currently so low it can be tempting for investors to reach out in the market trying to get some reasonable returns… only to realize too late they didn’t have the stomach for how volatile the stock market can be.
The best way to beat inflation is to have a plan in place that forecasts into the future how an estimated inflation rate will increase your spending needs. Then see what types of investments it would take to have the growth potential to meet those spending needs. This plan should also incorporate your lifetime income sources, like Social Security, into the calculation.
Sometimes small tweaks in a plan can have a huge impact between reaching your retirement goals versus falling short.
P.S. To make sure you do your 401(k) rollover the right way, download the 401(k) Rollover 10-Point Checklist today!