Why retirees should know about inflation risk – and how to fight it
Nearly half the current U.S. population was not even born when inflation skyrocketed to 14 percent in the 1970s. We might not see that again, but a strong-yet-unpredictable economy, along with a succession of interest rate hikes, suggests inflation could ramp up again in the months and years to come.
A variety of factors affect inflation, and its significance should not be overlooked by retirees, as complacency may leave you exposed to significant negative implications.
What is inflation risk and how could it affect me?
Simply put, inflation means that a good or a service costs more today than it used to in the past.
Remember when the yearly average price at the pump was below $1.00? The year was 1988, and it cost roughly $0.90 per gallon (the average Super Bowl advertisement at the time was $645,000, compared to $5 million this past February). Today, the national average for regular unleaded is $2.46. Of course, there are many forces at work that influence the price of gasoline, and Super Bowl advertisements for that matter. The takeaway is that accelerating inflation means higher prices for everyday goods and services. Think of gasoline, groceries and medicine.
The risk of high inflation is that the growth of retirement benefits and savings may not be keeping up with the accelerating pace of rising prices. For example, the cost-of-living adjustment (COLA; helps to offset inflation) for Social Security benefit recipients is not keeping pace with price increases this year for many common goods and services. The Social Security COLA for 2019 is 2.8 percent, coming after a 2 percent increase for 2018 – both of which were major increases from previous years. As big as it is, the 2.8 percent COLA hike still compares unfavorably to the Bureau of Labor Statistics’ unadjusted 12-month increases of 16.1 percent for gasoline and 3.2 percent for housing as of October of this year.
While you may not feel the dynamics of inflation on a daily basis, over time, the compounding nature of inflation erodes wealth.
Will inflation pick up?
Looking forward, inflation, as measured by the Consumer Price Index (CPI), has accelerated 2.5 percent in the previous 12 months as of October 2018. Headline inflation – a measure of total inflation, including food and energy prices, which tend to be much more volatile – is forecast to stay the same in 2019.
An important factor will be the number of interest rate hikes that the Fed makes in 2019. Some predict as many as three, while recent projections suggest there may be only one. Rate hikes tend to decrease inflation, while reductions increase consumer spending.
However, your personal inflation gauge may be higher or lower than the headline rate, depending on your lifestyle and spending needs. For example, if you enjoy cooking at home, your food cost inflation will be much lower compared to someone who goes out to eat more often. Geography matters, too, as it’s more expensive to live in the San Francisco Bay Area than Western Pennsylvania – the point being that inflation is relative.
What strategies can I use to offset the inflation risk during retirement?
Inflation risk doesn’t have to turn your golden years into silver or bronze. There are numerous strategies to weather inflationary periods.
Some assets are essentially immune to inflation. Real estate, for example, rises along with the rate of inflation, so your own home and rental properties maintain their value at times of higher-than-normal inflation, and you have the option to raise rents to offset other losses. Investments in commodities or in commodity-producing companies may also appreciate. It’s important to note that these assets may be subject to volatility and risks unique to their asset class in short-term periods.
Less risky, Treasury Inflation-Protected Securities (TIPS), tend to function pretty much as described, with the principal of the bond increasing in periods of inflation and decreasing in periods of deflation. When these bonds mature, you are paid the adjusted principal or original principal – whichever is greater. The potential growth in principal and interest income are exempt from state and local taxes, but subject to federal income tax. The bonds are offered in 5-, 10- and 30-year increments, so for someone nearing or past retirement age, bonds with shorter terms are likely the better options.
For those with the means, immediate inflation-adjusted annuities come with annual cost-of-living increases. The catch is the payments will likely take upwards of a decade to catch up to immediate annuities tied to interest rates, so this would be more of a complement to your retirement income.
Integrated with a careful review of your cash-flow needs and spending habits, you should be able to implement an investment approach that will hedge against inflation erosion. The key is devising a strategy that supports your retirement goals while putting you in position to defend your assets from the threat on the horizon.
Matthew Helfrich is a partner and president of Waldron Private Wealth, a boutique wealth management firm located in Bridgeville, Pa.