Even a Low Inflation Rate Can Decimate Your Retirement Savings
How to protect your nest egg and your lifestyle
Inflation is so low these days, 2% roughly, it’s barely noticeable. But think about this:
If inflation continues at a 2% annualized rate, what costs you $100 today will cost nearly $165 in 25 years. In 30 years you will need more than $180 to buy what $100 buys today.
Suppose inflation creeps back up to its longer-term norm of about 3% a year. You will need more than $200 in 25 years to pay for stuff that runs you $100 today. In 30 years you would need nearly $245 to pay for stuff that costs you $100 today.
That 25- to 30-year time frame is the key to successful retirement planning. If you land at 65 in average health, there’s a good chance you will still be alive at 90.
That life expectancy should be motivation to move inflation front and center in your retirement planning.
Especially given the fact that some key expenses for retirees have been climbing at an even higher rate. According to federal data, medical service inflation ran at 4.6% in 2019, and hospital services inflation rose 3%. Over the past 10 years, those two costs have risen 37% and 55%, respectively. That’s just one decade. Your retirement could last two or three decades.
Then there are day-to-day expenses. The Bureau of Labor Statistics reports that the average consumer cost for food has risen nearly 20% over the past decade. Transportation costs in U.S. cities increased 11%, as have electricity bills. Cable and satellite TV service costs are up 33%.
Even if you own your home outright, your housing costs won’t be immune to inflation. As home values rise, there’s a good chance your property tax bill will also climb. Replacing your HVAC or roof at some point in the future will also likely cost more. Plan on hiring (more) help for chores and maintenance as you age? Well, chances are those folks are going to charge more 10, 20, 30 years from now.
You get the idea. Rising prices need to be baked into your retirement strategy:
Pay attention to inflation when using retirement calculators. Some retirement calculators embed an assumed inflation rate, others ask you to plug it in yourself. Ideally it would use the long-term average of around 3%. If you are able to plug in an assumed rate, again, run the numbers using 3%. Want to be even safer? See how things shake out if you plug in 4%.
Don’t play investments too safe. Come retirement, it’s natural to want to take less risk. But parking all your money in cash or high-quality bonds likely means your money won’t grow at a pace that keeps up with inflation. High-yield online savings accounts currently pay about 1.75%, which is less than inflation. The yield on the Bloomberg Barclays U.S. Aggregate bond index, which is the benchmark used by core index bond funds popular in retirement plans, has a current yield of 1.9%.
Do you need cash and bonds? Absolutely. But keeping all your money “safe” is actually risky, in that your money won’t be growing enough to pay bills a decade or three down the line.
You also likely want to consider owning some stocks; over the long-term, stocks have delivered the best inflation-beating gains. You are retiring, but your portfolio still needs to work for you for another 25 or 30 years. That’s an argument for not completely bailing on stocks.
A basic rule of thumb: Subtract your age from 100 (or 110 if you have a family history of longevity). That’s how much you might want to consider keeping in stocks. So if you are 65, you would aim for 35% in stocks. Figuring out the right mix of stocks, bonds and cash is one of the trickiest parts of retiring without anxiety. Working with a fee-only financial planner to help you think things through and run the (inflation-adjusted) numbers can be a smart move. (Hint: If you’ve got a tax refund on the way, perhaps you might want to use some of that to hire a financial planner for a one-off assignment. Plenty will charge by the hour or by the project.)
Wring the most out of the best inflation-beating income you will have in retirement: Social Security. OK, by now you’ve likely heard all about the value of waiting until age 70 to start receiving your Social Security: Your benefit will be 76% higher than if you start at 62. An additional benefit of waiting is that all Social Security benefits are adjusted for inflation.
If you’re lucky enough to have a pension, chances are the payout doesn’t adjust for inflation. If you buy an income annuity, adding an inflation adjustment will cost you plenty more in a premium. But Social Security provides an inflation adjustment for “free.” It’s up to you to make the most of it.