Rising Prices and Investments: A Close Look at How Retirement Accounts Can Be Impacted During Periods of Inflation With inflation increasing by 5 percent from May 2020 to May 2021, it can be helpful to understand how inflation works, along with its impact on long term savings.
By The Epoch Times •
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Inflation increased by 5 percent from May 2020 to May 2021, as reported by the U.S. Bureau of Labor Statistics. The projected inflation for the coming year sits at 2.26 percent. Still, those saving for retirement and considering their future are frequently feeling nervous.
Perhaps rightly so. "While a moderate and consistent degree of inflation is generally considered a sign of economic health, rapid price increases can have a destabilizing effect on an economy, and they can jeopardize hard-earned retirement savings," says Thomas J. Brock, a financial advisor at Best Small Business Loans. "Over a sustained period of time, the result can be devastating, financially and emotionally."
To mitigate risks associated with inflation and retirement savings, it can be helpful to understand how inflation works, along with its impact on long-term savings and spending. Following is a brief look at what inflation is, how it can affect retirement accounts, and what you may need to consider when facing a period of inflation.
What is Inflation?
"Inflation is defined as the period-over-period increase in the price of commonly used goods and services in an economy," Brock says. Think of what you paid for a meal at a restaurant or a tank of gas a decade ago. Then consider what you spend today for that same meal or tank of gas. Over time, prices tend to rise, and this increase reflects inflation.
Not all sectors react the same to inflation. In a typical household, "some expenses are directly affected, some less so, and some not at all," says Drew Parker, the creator of The Complete Retirement Planner. For instance, if you have a mortgage with a fixed rate, your monthly payments will usually be based on that interest rate. Thus, they will not typically change with inflation. The same is true for other payments based on fixed interest rates, which might include installments on a personal loan or auto loan.
Other expenses, such as groceries, utilities, travel costs, and rent may go up during times of inflation. As interest rates rise, the amount you'll need to pay back when you take out a new loan could rise also. To cover costs, consumers usually either look for ways to cut back on some expenses to pay for others, earn more income, or find other ways to downsize their lifestyle.
Inflation and Retirement
Price hikes related to inflation are often felt most by those living on a fixed income, such as retirees. "In a typical retirement period of 25 years, a 0.25 percent increase in inflation could easily represent increased costs of about $200,000," Parker says. This means that if you begin retirement expecting a 2.75 percent rate of inflation during a 25-year period but face a 3 percent rate of inflation (representing a 0.25 percent increase) over the course of those 25 years, the change could cost you hundreds of thousands of dollars.
For those saving for retirement, paying attention to inflation rates can help as you choose investments and establish financial plans. "If inflation is running at 3 percent annually, you want your retirement account to outperform that number," says Chris Castanes, president of Surf Financial Brokers in North Myrtle Beach, South Carolina. "If your savings or money market account is only getting you 1 to 2 percent, then you aren't keeping up with the inflation rate."
Making Decisions about Retirement
If you're living in retirement, it can be helpful to monitor inflation rates and meet with a financial advisor periodically to review your financial situation. If you note inflation is on the rise, you can adapt to meet the changing environment. "Maintaining a flexible budget, where you temporarily adjust living expenses downward during challenging times, can be highly beneficial," Brock says. When doing so, you can pay attention to prices in your region, as they may be different than costs in other places. While the price of fuel might go down in your area, for instance, health costs could increase. You may look for ways to reduce transportation costs or travel less, while allocating more funds from your budget toward needed medical expenses.
When looking ahead to retirement, you may be able to adjust your savings and accounts to prepare for higher inflation. "Your retirement portfolio can be proactively designed to hedge against inflation," Brock says. You might speak to your financial advisor and consider diversifying in ways that will protect your funds. Some of these options might include allocating investments in different assets such as gold or real estate. You may also hear about incorporating Treasury Inflation-Protected Securities (TIPS) into the fixed income portion of your retirement plan. "These high-quality, U.S. government bonds are indexed to inflation, which protects investors from a decline in the purchasing power of their money," Brock says. Additional ways to diversify might include allocating funds in certain equities like stocks. Before making any decisions, you'll want to consider your timeline for retirement, look at your current financial situation and future expectations, and then fully research the available options.
By Rachel Hartman
