How To Prepare Yourself for Inflation During Retirement

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Here are three steps to help you prepare for inflation during retirement.

Key points

  • Inflation rose 7% the past year, the highest since June 1982.
  • One of the biggest risks retirees face is inflationary risk.
  • Investors can choose investments that rise with inflation, and regularly review their financial plans.

Inflation has been called the "cruelest tax," since it means retirees pay more than they are used to for the same goods and services. Inflation rose 7% in the 12 months through December 2021, hitting a 40-year high. If a retiree's savings account earned 4% during that period, this means they are in fact 3% poorer.

Rapidly rising inflation makes it difficult for retirees on fixed incomes to pay the bills. But by making the right financial decisions, you can make your money last longer. Here are three tips to prepare yourself for inflation during retirement.

Factor inflation into your retirement plan

Ensure that your financial plan factors in the impact of inflation. Inflation increases expenses such as healthcare, food, and housing. If you believe high inflation will continue, revise your inflation assumptions, update your financial plan, and monitor it regularly.

Social Security increased the cost-of-living adjustment (COLA) by 5.9% in 2022, the highest in 40 years. More than 64 million Americans saw a change in benefit payments. While the annual COLA helps those receiving benefits keep up with the increasing cost of living, it often isn’t enough.

A comprehensive financial plan can help ensure that you adjust your spending, your investment portfolio, and your financial goals to keep up with the rising costs of retirement. Those close to retiring may need to adjust their goals or increase how much they save, and stick to their long-term plan.

Diversify your investment assets

Choose investments that keep up with or even surpass inflation. Stocks, gold, and real estate are assets that can help protect against inflation. Real estate investment trusts (REITs) are an excellent way to invest in real estate without having to purchase property outright. Most REITs also pay a dividend, so they can produce income.

Treasury inflation-protected securities (TIPS) are low-risk, government-backed securities that base their return on inflation. The interest is exempt from state and local taxes, and the interest is paid every six months. The U.S. government also offers low-risk I bonds to help protect savings from inflation. An I bond is a savings bond that earns a fixed interest rate, plus an inflation rate that is set twice a year. The combined rate for I bonds issued from November 2021 through April 2022 is 7.12%.

Retirees should keep a diversified portfolio that has investments considered inflation-safe. The average retiree will spend up to 30 years in retirement. It is important that, when looking at a portfolio from a long-term perspective, retirees keep in mind that there will be periods of high and of low inflation.

Keep a long-term outlook

It is also important to not make drastic changes based on current inflation. While investors should prepare for moderate to high inflation for the next several years, many experts believe inflation will eventually return to normal. According to the Survey of Professional Forecasters from the Federal Reserve Bank of Philadelphia, economists expect CPI over the next 10 years to average 2.55% annually.

The key is not to let short-term market movements dictate long-term financial plans. While diversifying a retirement portfolio can help stave off inflation risk, taking on too much risk can expose investors to losses they may not be able to recover from. If possible, defer purchases that are affected by the temporary price hikes.

Investors can’t prevent inflation, but by preparing for it, they can lower its impact. There is no perfect inflation hedge, so it is important to be consistent and have a long-term outlook. By regularly reviewing financial plans and investment portfolios, retirees can manage them in real-time and make changes as needed.

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