Here’s How Inflation Might Affect Your Retirement Planning
During retirement planning, most people tend to overlook one of the most important factors – inflation. If you look at the previous three decades or so, inflation every year has been around 3% on an average. It’s quite surprising that people don’t attach that much importance to inflation while they apply all strategies to accentuate their savings. The price of goods and services rises due to inflation. If inflation happens at a 3% average rate in 2019 and 2020, the same goods and services will cost you 6% more in 2021. So, if you don’t take inflation into account, chances are that your money won’t last you long. Inflation certainly has a huge impact on the savings you have set aside for retirement. How? Find out.
The Effect of Inflation on Investment and Savings
If you are one of those people who prefer to push their money in investments and into their savings account, their value will automatically come down due to inflation. For example, if you are keeping aside $5000 every year for a time period of 30 years, you will have $505,365 in your hand once that time is over, provided that you are receiving an annual return of 7% throughout. That is indeed impressive.
However, inflation won’t allow you to lay your hands on that amount, unfortunately. The value of $505,365 in the future will approximately be equivalent to what $208,204 is in today’s time. You will have the same amount of dollars then. However, the value of those dollars will be much less than it is now, owing to inflation. As inflation would force the cost of goods and services to rise, you will have to pay for the future price tags.
Social Security and Inflation
A majority of the senior citizens rely on the benefits they receive from Social Security. With that being said, these benefits to are affected by inflation. The Social Security benefits get COLAs or cost-of-living adjustments because of inflation. As per the reports, the recipients were awarded a 2.8% adjustment in the year 2019, the highest one in seven years. While these adjustments are good for the seniors, many observers think that the exact pace of inflation is underrated by the benchmark used by the Social Security Administration.
The annual price changes are measured by the SSA. The determining factor here is the CPI-W or Consumer Price Index for Urban Wage Earners and Clerical Workers. Once that’s done, the SSA decides whether it should award a COLA or not. If yes, then how much the adjustment should be. However, the CPI-W doesn’t attach that much significance to those sectors that have gone through a high increase in prices. For instance, the healthcare sector has experienced a steep rise in prices as compared to the other sectors.
The cost of prescription drugs has experienced a rise of 188% between the years 2000 and 2018. This is as per the reports furnished by the Senior Citizens League. Due to this relative underestimating, even COLAs couldn’t save a 34% decline in the purchasing capacity of Social Security. Social Security is, of course, very important during the retirement phase. But that doesn’t mean it will stay unaffected by inflation. Make your plans with that in mind.
Investment Choices and Inflation
What should be your course of action, now that you know inflation would force prices to rise and Social Security will fail to keep up with it? The most practical thing to do in such a situation is considered inflation when planning out investments. Bond yields can be much lower as compared to the inflation rate. Stocks happen to be among those investments offering returns that can surpass inflation. The stock market in the United States has offered 7% returns on average. However, stocks have their own risks.
Deduct your age from 110. What you get is the percentage of your financial portfolio you can utilize for investment in stocks. Push the remaining amount to fixed-income investments. If you are a 30-year-old, invest 80% in stocks and the remaining 20% in fixed-income investments. If you are a 70-year-old, 40% goes to stocks, while 60% goes to fixed income.
These are a few examples of how inflation can affect your retirement planning and what steps you can take to fight inflation. You need to consult your financial advisor to devise an inflation-proof retirement strategy.
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