Last week we talked about longevity risk, which for retirees basically means outliving your money. Another risk that quietly creeps in during the retirement years is inflation. You may also hear this called “purchasing power risk,” and it essentially means your standard of living will decline over the years.
Right now inflation may not seem much like an issue (indeed, the Federal Reserve has been more worried about deflation recently). But over a period of 20 to 30 years, which many retirees can expect to encounter (especially those who retire early), inflation can be a real problem—especially if you’re living on a fixed income, which many retirees are.
For instance, inflation has been running at an annual rate of about 0% to 3.8% over the last 10 years, depending on which 12-month timeframe you’re looking at. You’d need about $125 today to buy something that would have cost only $100 back in 2003. In more specific terms, a gallon of gas cost about $1.50 in ’03; today that same gallon is about $3.00. A loaf of bread was about $1.00 10 years ago; today it’s around $1.50 on average, depending on where you live (and shop). In 2003, a stamp cost 37 cents; today it’s 46 cents.
Over longer periods of time (20 to 30 years), inflation has been running in the 3 to 4% range historically. Of course, there’s no knowing what inflation will do in the future. But retirees should plan on fighting the corrosive effects of inflation somehow.
The good news in the purchasing power battle is that Social Security is indexed for inflation, so your Social Security retirement benefit “should” keep up with inflation. Of course that varies depending on your actual purchase habits, but at least it’s something. Other income sources like most pensions and annuities are often not adjusted for inflation. So over time, these retirement dollars just don’t go as far.
As a retiree investor, you can combat inflation somewhat by using stocks (or stock mutual funds) and real-estate related investments (like real estate mutual funds) in your IRAs and variable annuities (traditional annuities provide a fixed income, whereas variable annuity payments vary, depending on investment performance). Stock-type investments have historically done a good job of staying ahead of inflation over long periods of time (but as you know, stock prices can change dramatically from month to month); real estate also has a good track record of staying ahead of inflation over the long term.
So if you can put a portion of your retirement investments in stocks/real estate-type investments, you may have a better chance of keeping up with inflation over the long haul, helping to maximize your retirement readiness. And as a retiree, you won’t have to lower your standard of living in your golden years.