How to Safeguard Your Retirement Savings from Inflation

April 26, 20236 min read
How to Safeguard Your Retirement Savings from Inflation
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Key Takeaways

  • Measured as an annual percentage hike, inflation is what occurs when general price levels of goods and services in an economy increase and thus the purchasing power of money decreases.
  • Inflation, which is an increased cost of living, means that retirees must spend more to maintain their standard of living.
  • Financial advisors generally recommend assuming an annual 3% inflation rate when making retirement plans and investing.

Most people who are set to retire are increasingly focused on funding their Golden Years and protecting their savings. There are steps individuals can take to help ensure their financial stability throughout retirement, including accounting for inflation when planning and investing savings. Afterall, inflation can markedly diminish the buying power of retirement funds over time. Thus, it helps to understand the market condition and how to safeguard retirement savings.

What is Inflation?

Measured as an annual percentage hike, inflation is what occurs when general price levels of goods and services in an economy increase, which causes the purchasing power of money to decrease.

Inflation can render it difficult for retirees, especially those on fixed incomes, to keep up their lifestyles without proper planning. Prices tend to rise each year, some years more than others, and can cause savings to quickly dwindle.

Note that this country’s average annual inflation rate over the last few decades has been around 2%-3%, soaring 9.1% from June 2021 to June of last year – the largest increase in some 40 years. Inflation has eased for the last 11 months – it is now around 4.9% — and some economists predict a rate drop to 2.8% for all of 2023.

The two types of inflation are:

  • Demand-pull. This is when demand for goods and services increases, resulting in higher prices.
  • Cost-plus. This happens when production costs such as wages or raw materials go up, causing prices to increase.

The Impact of Inflation on Retirement

As noted, an increased cost of living means that retirees must spend more to more to keep up their standard of living. As it is, retirees are more apt than other demographics to spend more on goods and services that are markedly affected by inflation, including food, housing, and healthcare. And if retirement savings are not increasing at a clip that surpasses inflation, some retirees’ finances may become imperiled.

Consider that, according to the Bureau of Labor Statistics, inflationary rates from July 2021 to July of 2022 averaged around 8.5%, which lowered the value of $100 to $92.17. If such a rate continued, retirement savings’ buying power could have further eroded to $44.23 after a decade and only $19.56 after two decades.

Inflation and Pensions and Social Security

In addition to retirement savings, inflation can affect retirement savings accounts such as pensions and Social Security.

For some retirees, pensions will be their chief source of income, albeit for their entire lives. Inflation can affect pensions in some ways. For instance, pension plan benefits are usually based on the last several years of the employee’s salary, which could be pre-inflation wages.

If inflation levels were high during those last working years, the retiree’s benefits could be unfavorably affected. Further, inflation adjustments are not always a part of a retiree’s pension benefits. In that case, the retiree will need to independently make up the difference.

Meanwhile, the government benefit Social Security, one of the largest sources of income for retirees in general, can also be impacted by inflation. In fact, the yearly review of the inflation index is a key part of Social Security. The purpose of the review is to shield beneficiaries from erosions in buying power, so, each year, benefits are adjusted annually based on the cost of living. However, throughout history, such adjustments have been low, which really equates to a progressive loss of purchasing power.

Inflation and Your 401(k)

Long stretches of inflation can also negatively affect 401(k) returns, which have typical targets of 5-8%. To illustrate, say the current return on one’s 401(k) is 10.5% and inflation is at 8.5%, the investor’s gain would be just 2%. And a return of 8% would yield a negative net gain.

Still, such accounts do have advantages, including tax breaks and withdrawal flexibility, and one can take steps to mitigate inflation’s effects by maintaining contributions, diversifying investments to manage potential loss exposure, and supplementing savings with an individual retirement account.

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Investment Strategies for Combating Inflation

There are other ways to go about countering inflationary effects, all of which underscore the importance of investing for retirement, whether in stocks, bonds, or less volatile, “alternative” assets such as real estate, which generally provides a reliable shield against inflation.

Still, according to a 2022 study, some 54% of adults said that inflation had caused them to stop or slash their retirement savings contributions. So, those among that number must get back on track with such savings.

And note that while inflation has risen at an abnormally fast rate in recent years, financial advisors generally recommend assuming an annual 3% inflation rate when making retirement plans.

Strategies for beating inflation include:

  1. Paring spending. Examine spending to see where cuts can be made. Reducing one’s spending can increase retirement savings.
  2. Working with an adviser. It can make sense to have a knowledgeable professional go over one’s financial situation and help with investment goals and guidance.
  3. Investing in inflation-protected securities. The interest rate on these securities – a type of bond – is adjusted to keep pace with inflation.
  4. Creating a retirement plan. To stay on track financially, it is advisable to have a plan that factors in inflation and other considerations and include a budget, a plan for optimizing Social Security benefits, and a strategy for withdrawing retirement savings.
  5. Learning about investment options such as IRAs, annuities, and health savings accounts.

Common Retirement Planning Mistakes

There are some common mistakes that people make when planning for retirement, including:

  • Dipping into retirement savings. Anyone tempted to dip into retirement savings should be aware of possible tax implications including a 10% penalty plus any taxes owed.
  • Failing to account for inflation. The costs and goods and services will likely go up each year, which will diminish one’s buying power if savings and investments are not properly managed.
  • Not considering tax implications. It can be a very costly mistake to overlook the possible tax implications of early withdrawals from retirement accounts such as IRAs.
  • Underestimating healthcare costs. While there may be no particular health issues now, one can count on that changing as one ages. Plan accordingly.
  • Not regularly reviewing and adjusting the retirement plan. Life is not static, so it is important to review and modify one’s retirement plan as circumstances change.

Another mistake is putting too much pressure on too few investment assets. Particularly when inflation is up, it is crucial to diversify ones investment holdings by allocating capital across various kinds of securities, including alternatives. The latter can generate passive income while diminishing overall portfolio risk.

Alternative Investments and Portfolio Diversification

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments. This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. Learn more about the ways Yieldstreet can help diversify and grow portfolios.