As a financial planner, I know that there are many risks threatening a retiree’s nest egg. But if you ask me what the most underestimated threat to a secure retirement is, my answer might surprise you. It’s not a stock market crash or a real estate bubble. It’s a slow, quiet, and relentless force: inflation.
For decades you’ve worked, saved, and built a nest egg you hope will last a lifetime. You’ve planned your budget based on today’s costs, hoping they remain the same. But inflation can sneak into your plan and slowly erode the purchasing power of every dollar you’ve saved. That $5 cup of coffee becomes $8. The $40 tank of gas becomes $70. Over a retirement that will span 30 years or more, this effect uses compound interest against you and can derail your retirement spending.
Let’s break down why inflation is such a big risk and, most importantly, what you can do to fight back.
Why is Inflation a Retiree’s Biggest Foe?
For someone in their working years, inflation is a nuisance, but often manageable. Their salary may increase with or more than inflation, and they have time for their investments to grow and outpace rising prices.
Retirees, however, have it harder. You’ve shifted from saving your money to spending it. Part of your retirement income may be fixed, coming from sources like pensions or annuities. You may have put your money in cash and bonds to protect from a stock market correction (we don’t recommend this). So, when the cost of everything from groceries to electricity goes up, most of your income won’t automatically rise with it. Each dollar buys a little less, and your carefully planned budget gets squeezed tighter and tighter.
Historically, we’ve seen inflation rates in the ballpark of 3% per year. I can’t predict what rates will be in the future, but if this 3% figure continues, you could expect to see prices doubling about every 24 years.
A 65-year-old retiree has 20-30+ years of retirement ahead of them. Even a seemingly modest 3% inflation rate can quickly cut the purchasing power of your initial retirement savings in half.
The Rising Costs of Healthcare
One area where inflation hits retirees hardest is healthcare. Historically, the inflation rate for medical services is closer to 4.5%, which significantly outpaces the general rate of inflation. For retirees, who typically have higher healthcare needs, this is a major financial threat. Rising costs for prescription drugs, insurance premiums, and long-term care must be appropriately planned for.
Protecting Against Inflation
The good news is that you are not powerless. A proactive financial plan can help protect you from the corrosive effects of inflation. Here are three key strategies we discuss with our clients.
1. Maintain Exposure to Stocks
While many retirees think shifting to an all-bond portfolio is a good idea to reduce volatility, completely abandoning stocks is a mistake. Over the long term, the stock market has historically provided returns that outpace inflation. Companies can often raise prices for their goods and services, allowing their earnings to grow with inflation. A diversified portfolio of stocks should remain a core component of your retirement assets to provide the growth needed to maintain your purchasing power.
2. Incorporate Inflation-Protected Securities
The U.S. government offers securities specifically designed to combat inflation. Treasury Inflation-Protected Securities (TIPS) are bonds whose principal value adjusts with inflation. This means that as prices rise, so does the value of your investment and the interest payments you receive. While not a high-growth asset, TIPS can provide an inflation-adjusted return for a portion of the bonds in your portfolio. But, TIPS do not offset the need for stocks in your portfolio.
3. Maximize Your Social Security Benefits
One of the benefits of your Social Security payments is that they come with built-in inflation protection. Each year, your benefit is adjusted based on inflation. One strategy to hedge against inflation is to delay taking Social Security until age 70, if it makes sense for you. If your full retirement age is 67 and you delay your benefits until 70, your benefits automatically increase by 24% (8% each year you delay). This results in a much higher starting benefit, and every future COLA will be applied to that larger base amount, creating a compounding effect over your lifetime.
Don’t Panic, Plan
Seeing the price of everyday goods go up can be unnerving, especially when you no longer receive an increasing paycheck. But remember, inflation is not a new phenomenon. It’s a necessary factor of our economy that can be planned for and managed.
The key is to move from a reactive mindset to a proactive one. Address inflation now, not after you’ve had to cut your expenses. By building a diversified, inflation-aware portfolio, you can protect your hard-earned dollars and ensure that your golden years remain truly golden.