Why is inflation so scary for my retirement plan?

Over the past decade, investors experienced a best-case scenario of relatively low inflation and strong investment returns from both stocks and bonds. A retirement portfolio could maintain or even grow in value, enabling a retiree to comfortably sustain a withdrawal rate that met their spending needs. For many, worrying about inflation seemed to be a thing of the past.

That perspective has changed as rising inflation has become headline news and the potential for further pressure on price levels is coming from a number of sources. These include: (1) massive monetary stimulus; (2) reopening of the economy following the pandemic; (3) a surge in consumer spending as a result of rising net worth; and (4) inventory rebuilding by businesses.

As the prospects for higher inflation mount, many retirees and those planning for retirement are worried that their investment portfolios may fall short of expectations.

What does history tell us?

An environment of high inflation and low returns may be uncommon, but its impact on investors can be severe, as our experience in the 1970s illustrates. In 1973, the inflation rate increased to 6%, and the S&P 500 dropped 15%. The inflation rate was 11% in 1974, and stocks lost 26% of their value. Interest rates were high from a historical perspective, resulting in fixed-rate investments generating more interest income for retirees. However, inflation consumed the increase in income. This experience from 50 years ago may be contributing to concerns that investments might not keep pace with inflation in the future.

Swings in inflation rates such as those we have witnessed over the last several decades can have a significant impact on retirement security. Rising price levels cause you to spend more to maintain your standard of living, which often means having to take larger withdrawals from your portfolio.

Also, differences in the inflation rate of a few percentage points can add up over time.

How can you prepare for a secure retirement in the coming environment?

We believe that the environment in the coming decades will most likely resemble the period from the 1980s through the early 2000s. During these years, investors had either inflation or investment returns in their favor but not at the same time.

During the planning process, quality financial teams will help you build confidence by incorporating various inflation scenarios and assumptions as well as prioritize lifestyle needs, wants, and wishes. For example, healthcare costs are assumed to increase at a higher inflation rate than most other spending. However, additional discretionary travel for many clients is often considered a wish that can be a flat expense or only grows at the average inflation rate.

In addition to examining each of these expense categories in your comprehensive financial plan, it is important to review your withdrawal assumptions. Working together with your advisor, you can then decide if you need to be more conservative in spending.

As part of our portfolio management process, we provide you with insights on asset allocation and investment strategies to help you hedge against or even out-earn inflation over time. For example, investing in treasury inflation-protected securities and increasing the allocation to equities are strategies often utilized to increase returns during periods of high inflation. Investing in real estate, infrastructure, and other types of alternative assets may also be applicable.

It is also critical that your advisor helps you understand the difference between inflation and reflation and how each affects investment. And even in an environment of rising inflation, there are still reasons to consider fixed income as part of a diversified portfolio.

You may also find opportunities as part of the regular review of your comprehensive financial plan. For example, the planning process can help you explore the impact of other financial decisions, such as when to claim your Social Security benefit.

You may collect benefits at age 62, but waiting to claim as late as age 70 results in a larger benefit that is inflation adjusted. According to the Social Security Administration, the maximum monthly benefit at full retirement age in 2021 is $3,148; at age 70, it is $3,895. However, at age 62, it is only $2,324.

Knowing how inflation can impact your retirement is a key part of planning. Talk with your financial advisor to make sure this is part of your strategy.

Vince Lecce, CIMA® is Senior Vice President and Rochester Market Leader for Key Private Bank. He can be reached at (585) 238-4107 or [email protected]. 

Renee Porter-Medley, CFP®, MPS-OD, is a Regional Planning Strategist Key Private Bank. She can be reached at [email protected].

Any opinions, projections or recommendations contained herein are subject to change without notice and are not intended as individual investment advice. This material is presented for informational purposes only and should not be construed as individual tax or financial advice. KeyBank does not provide legal advice. KeyBank is Member FDIC. KeyCorp. © 2022.         CFMA #220331-1525936

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