Inflation – How to Fight the Uphill Battle

In the last twelve months, we have seen an inflation rate of 5%. 

Scott discusses some historical context on inflation, explains transitory inflation, and shares the importance of empowering our clients with long-term investment strategies to beat inflation. 

How Inflation relates to Income Planning 

Inflation has become a hot-button topic in 2021, coming out of the pandemic. The current rate has reached 5% due to factors like printing money in 2020 to help keep the economy in check while it was largely shut down. 

The result is that if cash or money in the bank that is not growing, it is now worth about 5% less and will buy 5% fewer goods and services. It is imperative to compensate for this for a successful long-term retirement plan. 

History and Transitory Inflation 

From 1970 through the 1980s, within about 20 years, the Consumer Price Index rose 233%. During the next 20-year period from the 1990s-2010, prices increased 73%, and in the last decade, prices have only gone up 20%. 

Since the inflation rate has been going down for the last few decades, some investors grew concerned when it jumped to 4.99% over the previous twelve months. A continued 5% inflation rate year over year would have a significant effect on the economy. 

The Federal Reserve believes that this rate is only transitory inflation meaning that the current rate will not be sustained. Inflation will still occur over time as part of a healthy economy; however, the Fed believes it will not continue at 5% year over year. 

How Inflation Affects a Retirement Plan 

Planning for inflation is crucial to effectively ensure money will not run out in retirement. 

Look at an example of a 65-year-old with $1 million saved in the total portfolio. Expenses are $100k with $60k in income, so $40k shortfall will need to come from investments. We will make a generous assumption that the guaranteed income, whether from Social Security, a pension, or another source, will grow by 2.5%. 

Scenario 1 – No Inflation 

15-year Outlook: Expenses stay the same with no inflation and income will increase, so less than 40% is needed from investments. 

30-year Outlook: Expenses stay the same and income will more than double, so now there is excess money for saving each year. 

Scenario 2 – 2.5% Inflation 

15-year Outlook: Expenses go up by over 40%, and the shortfall increases. 

30-year Outlook: Expenses more than double, and the shortfall more than doubles as well. Now over $80k will need to be pulled from investments to cover expenses. 

Beating Inflation with Investments 

At 2.5% inflation, what does that $1 million need to earn to compensate for the shortfalls? If it earns nothing, a 65-year-old will run out of money by age 80 or 90. Returns need to be as high as 4% to keep from running out of funds, but even that does not leave much excess. A little over 1% is left, and it would run out again if inflation went up to 3%. 

To make a long-term retirement plan work, investments must be placed in assets that will beat or at least keep up with inflation. 

The stock market is a great place to be long-term. Companies can raise prices as their cost goes up, pass those costs along to the consumer, and the investor benefits. Other viable options include real estate, commodities, and gold. 

Beating inflation is vital, even when looking for lower-risk investments. With the current inflation rate, consider using fixed annuities in the foundation of your financial house since they meet this criterion, while cash and CDs do not. 

Even with transitory inflation, prices will not necessarily go down. Inflation will continue, so speak with your advisor on how to beat it and how it will impact the overall success of your retirement plan.

If you have any questions, please don’t hesitate to call us at 844-CARLSON (844-227-5766).

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