Someone age 40 today may think that continuing to live on a $100,000 income in retirement might be just fine; however, assuming retirement at age 65 and a 3% inflation rate, it will take an annual income of over $209,000 to provide the same purchasing power.
Now, obviously, Social Security will provide a portion of that requirement, but it will likely be a minority portion. Let’s say Social Security provides $50,000 (coughing, maybe some chuckles), $159,000+ will still have to come from investments. How much will be needed? Rough guess: close to $4 million!
Oops. Better start saving.
How about those getting ready to retire? What should they do? At the risk of sounding self-serving, get an advisor. Generic information isn’t advice; but, here are some ideas you and your advisor should discuss.
Understanding Inflation
Remember money is not about how many pictures of Presidents you have. Money is worth only what it purchases.
Inflation rates can vary widely from year to year and are influenced by factors such as government policies, economic growth, and global events. While moderate inflation is considered healthy for economic growth, too much inflation can wreak havoc on savings and investments if not properly managed.
Strategies to Protect Wealth Against Inflation
There are only three things you can do with money:
- you can loan (bonds, cds, savings, etc) – a strategy that historically doesn’t hedge inflation especially after taxes
- you can own, or
- you can bury it in your back yard (or some other convenient location) – a guaranteed loss to inflation)
Two out of those three will lose to inflation. Ownership of assets always seems to do better – go figure.
1. Real Assets
Real assets are tangible assets that tend to retain or increase in value over time, keeping pace with or outpacing inflation. Examples include:
Real Estate: Property values generally rise with inflation, making real estate a popular inflation hedge.
Commodities: Precious metals like gold and silver, as well as other commodities like oil and agricultural products, often maintain their value during inflationary periods.
Infrastructure: Investments in infrastructure projects such as toll roads or renewable energy facilities can provide stable returns that adjust for inflation.
Diversifying into these real assets can help cushion your portfolio against the erosive effects of inflation.
2. Stocks – equity in the companies that sell products
Have you been at the grocery checkout lately? Upset about the prices? Do you own equity in any of the companies that are selling all those products at higher prices? Hmmm. These are consumer staples: Companies that produce essential goods like food, household products, and pharmaceuticals often see increased revenues during inflation. Other equity ownership options include:
Natural Resources: Companies involved in mining, energy production, and agriculture can benefit from rising commodity prices.
Utilities: Utility companies typically pass on increased costs to consumers, maintaining their profit margins during inflation.
But, Jim! Stocks are risky. They go up and down!
Yes, but inflation seems to go up more consistently. By the way, your house goes up and down, too. Did you sell at the last price decline? Your car always goes down, but you still like it.
3. Inflation-Indexed Bonds
Governments issue inflation-indexed bonds (like TIPS in the United States) that adjust their principal and interest payments based on inflation rates. These bonds guarantee that your investment keeps pace with inflation, offering a reliable way to preserve purchasing power. Of course, as I said, there are taxes. What if you hold TIPS inside an IRA? You still have taxes – tax deferred means tax delayed. Do you know what your tax bracket will be in 20 years? Trusting Congress to spend less may not be a good plan.
4. Diversify Globally
Inflation rates vary by country and region, so diversifying your investments globally can help mitigate inflation risks. By spreading your assets across different economies, currencies, and markets, you reduce the impact of inflation in any one region.
5. Focus on Income-Generating Investments
Investments that generate a steady income, such as dividend-paying stocks, rental properties, or bonds, can be effective against inflation. Regular income streams adjust with inflation and provide stability during economic uncertainty. The lessons of Warren Buffett should not be lost on a forty-year-old: it’s not share price that matters, it’s the accumulation of shares over time that counts. The price of quality companies will take care of itself over time. Notice the long-term trend of the large indexes lately?
6. Avoid Long-Term Fixed-Rate Debt
During inflationary periods, the real value of debt decreases because you are paying back loans with less valuable currency over time. However, it’s crucial to distinguish between good and bad debt. While manageable mortgage debt on appreciating real estate can be beneficial, high-interest consumer debt can quickly erode wealth. And, don’t forget interest rate risk. A 1% rate hike and do a lot of damage to a 30-year bond.
How much should you own of any of the above? Consultant’s answer: it depends. It’s not as simple as picking a retirement date and choosing an allocation (target-date funds seem to assume that everyone 10 years from retirement with the same risk profile has the same income, spending needs, obligations, even number of children, I guess. Not every investment option, no matter how good for one person, may not be right for another. Remember: penicillin is a miracle drug, but some people are allergic to it.
7. Monitor and Adjust
Economic conditions and inflation rates change over time. Regularly review your investments and financial strategies to ensure they remain aligned with your goals and current economic trends. Adjust your portfolio as needed to maximize protection against inflation.
Practical Steps to Implement These Strategies
Educate Yourself: Stay informed about economic indicators, inflation rates, and market trends.
Consult Professionals: Never get neuro surgery advice from a podiatrist. Don’t get financial advice from your hairdresser. Never get legal advice from me – or even hair care, for that matter. The financial services industry is filled with meaningless credentials obtained at weekend hotel seminars – they make good marketing but are of little value. Make sure your ‘advisor’ – everyone seems to use that title these days – is the real deal.
Stay Disciplined: Stick to your long-term financial plan and avoid emotional reactions to short-term market fluctuations. That’s why it’s call investment discipline. People who have a real plan not only know what they’re doing, but why they’re doing it. Short term surprises don’t surprise.
“The only thing that surprises me is that we continue to be surprised when surprise happens.”
– Donald Rumsfeld, former Secretary of Defense
Known and Unknown
Review Regularly: Schedule periodic reviews of your portfolio and financial goals to make necessary adjustments. Remember, investments aren’t the only things that change. You’ll change, too! In addition to constant ageing, there are other issues: future purchases, births, deaths, college, vacations, – the list is long, but they’ll all impact your plan, particularly 20+ years out from now.
Conclusion
Protecting wealth against inflation requires foresight, diversification, and informed decision-making. You wouldn’t build a house without a blueprint; your financial future should be no different. By staying disciplined and regularly reviewing your financial strategies will ensure that your wealth continues to grow and preserve its purchasing power over time. Remember: think long-term.
Planning your retirement? This little tool may help you measure the impact of inflation on your retirement, and here’s a good place to get your ducks lined-up.
Enjoy!
Jim
