Inflation is a popular topic right now. Many news stories from the past few years are filled with dire warnings about unsustainable consumer prices and the plummeting value of the dollar.
Reading these reports can be frightening, especially if you are retired or getting ready to transition into retirement in the next few years. Inflation isn’t something that will ever go away, but it also isn’t always a bad thing.
Understanding the details of inflation and how it affects your retirement funds gives you the power to build a stronger, safer portfolio. When you work with Guiding Wealth, we can help you plan for inflation so it doesn’t negatively impact your retirement.
A Quick Overview of Inflation
Before looking at how inflation affects investments and retirement funds, it’s important to define exactly what inflation is. Simply, inflation is the term for the economic reality that the prices of goods and services are always increasing.
Inflation impacts almost every part of our daily lives. Prices on groceries, fuel, utilities, clothing, vehicles, and housing continuously increase due to inflation. It costs more now to travel, buy a home, purchase the Sunday newspaper, and feed your family. Inflation can be especially difficult for retirees with fixed incomes, because the value of each dollar decreases as prices rise.
Most economists believe that inflation isn’t something that can ever be completely eliminated. Moreover, most experts agree that a small amount of inflation is actually good; stagnant or rapidly decreasing prices can have a severe, negative impact on the economy. The challenge comes with big inflation rates like the ones we’ve seen in the last few years.
There’s always at least a small amount of inflation in the economy, but it’s been a far more significant factor recently. The U.S. Consumer Price Index (CPI) from October 2021 shows a 6.2% rate of inflation compared to October 2020. It’s the largest CPI surge since 1990. Even ignoring the rising costs of food and energy (which are included in the CPI), the annual “core inflation” was up 4.6%, which is the fastest increase in the last three decades.
Employers typically try to adjust wages for inflation by giving their workers cost-of-living adjustments (COLA) each year. The Social Security Administration also makes an annual COLA to benefits payments. The Social Security benefits COLA for 2022 is 5.9%, which is significantly higher than the 1.3% COLA for 2021. It’s another indication of just how much inflation is currently affecting the economy.
Inflation Affects Investors, Not Just Consumers
Many articles and studies on inflation focus on the way it affects consumers. Prices go up, which makes an individual’s money worth less, especially if their salary isn’t increasing at the rate of inflation. However, the effect of inflation on investors is actually something that’s more relevant for more retirees.
What you invest in the stock market, you are investing in each company whose stock you purchase. So when goods and materials go up in price due to inflation, most companies then increase the prices of their products to compensate. This is a good thing for you as an investor, because those higher prices generally correspond to increased stock values.
Inflation and Interest Rates
Inflation can increase the value of your stock market investments, but it can also be beneficial if you have bonds in your portfolio. One way that the government tries to manage inflation is by increasing interest rates.
Changes to government-set interest rates affect the interest rates in other parts of the economy. For example, a higher federal interest rate means higher mortgage rates. This is one reason that it costs more to buy a home when inflation is high. Rising interest rates don’t just affect home loans, though. The interest rates of bonds also increase, which means that the bonds in your portfolio go up in value.
How To Protect Your Portfolio Against Inflation
To protect your retirement portfolio against inflation, you need to make sure it can increase its value at a rate that’s at least as fast as inflation. The best way to do that is to make the right investments. By having both stocks and bonds in your portfolio, you can feel confident that the value of your investments will increase as inflation does.
Make a Retirement Plan That Accounts for Inflation
Inflation can have a significant impact on your retirement portfolio because it causes consumer prices to increase. With a solid investment strategy that utilizes stocks and bonds, however, you can benefit from inflation. Inflation and economic recession often go hand in hand. Check out our free Retirement in a Recession Guide to learn more about protecting your portfolio during a market downturn.
Then, schedule a consultation with a Guiding Wealth expert to get customized advice on building a portfolio that’s protected against inflation. Call 214-810-3835 to get started.