Inflation hit a 40-year high in May 2022. On many fronts, global prices have been rising due to pressures from supply chain disruptions, funds from COVID-19 relief checks, and the impact of the war in Ukraine. As a stark reminder, what a dollar could buy in 2000 now costs $1.70.
Escalating prices are both a long-term and a short-term scourge. Retirees on fixed incomes are particularly susceptible. They are anxious to clarify how inflation might affect their lifestyles, how long it will last, and how high it will reach. It may take the cruelest bite from lower-income retirees, who find themselves paying out proportionately more on food, energy, and medical bills.
Retirement expenses will change
Retirees may find it hard to accurately predict their likely spending patterns in the next 10 or 20 years. Many of us make the common mistake of using our current lifestyle expenses to predict future expenditures. Psychologists have even labeled the fallacy an “end of history illusion.” They mean that people regard the present as a watershed moment, underestimate the extent of possible changes, and end up blindsided by them.
The good news is that many expenses decline in retirement. For instance, costs go down for commuting. Homeowners have perhaps paid off their mortgages or even downsized, releasing equity and saving home-running costs. On the other hand, medical and assisted living costs loom. Retirement spending follows a predictable “go-go, slow-go, no-go” pattern, increasing at first on leisure, travel, and entertainment, then leveling off and ultimately resuming on health costs.
Another brighter story is that Social Security payouts offer retirees some protection, thanks to cost-of-living adjustments. The same holds for inflation-adjusted defined benefit plans and annuities. COLAs were 5.9% in 2022 and are scheduled to reach 8.7% in 2023. That buffer is widespread across the senior population, considering that a whopping one-third of retirees depend on Social Security for 90% of their income, and over half rely on it for 50% of their income.
However, many private pensions are tied to final salary rates, which high inflation may overtake. The glass also looks less full when you realize that Social Security benefits have lost a third of their purchasing power since 2000, according to the Senior Citizens League. From 2000 to 2020, Social Security payouts went up by 53%, but the cost of goods and services climbed 99.3% during the same period.
Investments for beating inflation
Retirees turn to these sources of income:
- Dividends.
- Interest.
- Rents.
- Leases.
- Annuities.
- Treasury inflation-protected securities.
There are risks. When interest rates rise in reaction to inflation, the economy starts to contract, credit becomes more expensive, and the cost of money itself goes up. As a result, companies produce lower earnings. With less profit reported in the bottom line, they may cut back or discontinue dividend payouts. (Bonds, fortunately, are much less likely to be affected, as long as companies can avoid an extreme collapse into bankruptcy.)
Short leases, which allow rents to keep rising, offer better protection for landlords; by contrast, longer leases can trap them at unfavorable rates. Similar basic principles apply to REITs and real estate funds, although commercial landlords tend to outperform in inflationary times.
Retirees may buy fixed annuities for some peace of mind, although a drawback is that investors lose access to their assets. Immediate annuities, which start paying out as soon as funds are deposited, guarantee a fixed income stream. Inflation-adjusted products may begin with smaller payouts, which means they might take years to catch up.
Treasury inflation-protected securities are bonds whose principal and interest rates increase with inflation.
Actions to take
When inflation starts to climb, follow these simple guidelines:
- Delay starting Social Security payouts if possible — waiting until 70 boosts benefits to 132%.
- Avoid penalties and taxes that result from cashing out IRAs and 401(k) accounts early.
- Maintain a diversified portfolio, including energy, commodities, and REITs. Stocks historically average about 10% a year, and businesses can pass on higher prices to customers.
- Don’t leave significant cash sums sitting uninvested. Banks make plenty of money from inattentive account holders.
Not every investment is right for everyone. Ask your adviser about the most suitable inflation investments for your needs. If you are nearing retirement, it might be time to create an estate plan. If you are ready to get your ducks in a row, send us a message through our Contact Us page.
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