Inflation and Its Impact on Retirement Planning

In this video, Matt Stevenson of Allied Wealth discusses the significant impacts that inflation can have on today’s retirees.

Inflation is a dreaded word for most people, especially those who are close to retirement. It is a concern that we often hear from people who come to meet us in the office. Understanding the true impact of inflation on your retirement plan is critical in today’s market economy. In this article, we will discuss what inflation is, how it impacts your purchasing power, and some ideas around how to inflation-proof your retirement plan.

What is Inflation?

Inflation is simply defined as the rate at which the cost of goods and services increases over time. The higher the rate of inflation, the less purchasing power our money has to buy those goods and services. Not all goods and services are affected equally, as some have increased in cost dramatically over the last several decades, such as hospital services, healthcare, housing, and food and beverage. On the other hand, some goods and services have become cheaper over time due to improved technology, such as furniture, new cars, clothing, and cell phones.

The Long-Term Impact of Inflation

The long-term impact and effects of inflation are very real. If we go back a few decades to the mid-70s, the last time we had a huge spike in inflation, we can see the impact on things like the minimum wage, which was about $2 an hour. Fast forward to now, and the minimum wage is $7.25 an hour, an increase of about 250 percent over that 40 to 50-year time frame.

Household median income has gone from about $13,000 a year to about $78,000 per year, an increase of almost 500 percent. However, the cost of a new car has gone up almost 1300 percent, the cost of a new home almost 800 percent, and things like long-term care expenses have gone up almost 2000 percent over that same time frame. These increases in the cost of goods and services are outpacing the rate of income that Americans make every day, every year.

What Goes Up Must Come Down

This current environment is very much a case of what goes up must come down. The Federal Reserve and the government have done a lot over the last year-plus to raise the interest rate environment. The reason why they’re doing that is to help cool down the rate of inflation in the economy, make sure everything’s firing on all cylinders, and we can move forward from there. However, it’s been a bit of a mixed bag.

Impact on Retirement Planning

Let’s talk specifically about the impact of inflation on retirement planning. The bond market is interesting because it has a seesaw relationship with the interest rate environment. As interest rates have gone up substantially over the last year-plus, that has actually dampened the value of most bond investments out there pretty heavily.

For decades, it was great to be a bond investor, but now we’re in a situation where interest rates have gone up, and it’s having a negative impact on the value of bond portfolios.

Those of you who have a pension plan, a lot of our retirees in the Houston area, especially those who work for big oil and gas energy companies or in the technology sector, or healthcare, may have a pension plan. When you think about your pension, it basically acts like a huge bond fund.

That relationship we just described very much impacts the value of your pension as well. As interest rates have gone up substantially recently, it’s having a negative impact on the value of your pension as well.

The stock and bond market are also impacted by inflation. The S&P 500 has gone down about 19 to 20 percent from the beginning of 2022 until now. A lot of uncertainty surrounds the economy and the rate of inflation.

Another way to inflation-proof your retirement plan is to consider alternative investments. Alternative investments are assets that are not traditional stocks, bonds, or cash. Examples include real estate, commodities, private equity, and hedge funds.

These types of investments can provide diversification and potentially higher returns, which can help offset the effects of inflation. However, it’s important to note that alternative investments often come with higher risks and fees, so it’s crucial to do your research and consult with a financial advisor before making any investment decisions.

Lastly, one of the most effective ways to inflation-proof your retirement plan is to increase your savings rate. By saving more money, you can accumulate a larger nest egg that can better withstand the effects of inflation. This means cutting back on unnecessary expenses, living below your means, and investing more aggressively. It may require some sacrifices in the short-term, but the long-term benefits can be substantial.

In conclusion, inflation is a major concern for anyone planning for retirement. As the cost of goods and services increase over time, the purchasing power of your savings decreases, which can have a significant impact on your quality of life in retirement.

However, by understanding the true impact of inflation, diversifying your portfolio, considering alternative investments, and increasing your savings rate, you can take steps to inflation-proof your retirement plan and ensure a comfortable and secure retirement. It’s never too early or too late to start planning for your future, so take action today to protect your financial future.

Also read: Understanding Net Unrealized Appreciation


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