After reaching a peak of 9.1 percent in June 2023, inflation has significantly dropped to 2.5 percent as of August 2024 over the previous 12 months, according to the Bureau of Labor Statistics.
Despite this decrease, many Americans remain concerned about the impact of rising prices on their retirement savings, following a period of high inflation not seen in almost four decades.
Sean Lovison, a certified financial planner at Purpose Built Financial Services, emphasizes the importance of ensuring that investment returns outpace inflation to maintain the real value of a portfolio over time.
One way to safeguard against inflation’s effects on a portfolio is by working with a financial advisor, according to Lovison.
Ways a financial advisor can assist in combating inflation
Financial advisors utilize retirement planning software to analyze various scenarios for a portfolio based on different inflation rate assumptions. This approach offers more detailed insights compared to using online retirement calculators or conducting individual calculations.
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Paul Winter, a certified financial planner at Five Seasons Financial Planning LLC, highlights the importance of stress-testing a retirement projection to assess its sensitivity to higher inflation levels for a client’s financial plan.
Winter often considers scenarios with a 3 percent inflation rate for clients to better prepare for potential cash flows and investment returns during retirement, aligning with the historical average inflation rate over the past century.
The Influence of Inflation on Your Financial Plan
Integrating inflation into a retirement plan can pose challenges, especially without professional guidance. Neglecting the impact of inflation on a portfolio can be a costly mistake for retirees or individuals nearing retirement.
According to Lovison, retirees drawing down their savings are particularly vulnerable to inflation’s impact, as they may deplete their funds earlier than anticipated.
Individuals already in retirement are more negatively affected by higher inflation due to fixed incomes and the absence of potential wage growth to offset rising prices, Winter explains.
Retirees heavily invested in cash and fixed-income assets, like bonds, face risks as higher inflation erodes the value of cash over time.
While Social Security offers a cost-of-living adjustment based on the Consumer Price Index, rising Medicare premiums and increased healthcare costs may offset a significant portion of the adjustment.
Brad Wright, a certified financial planner and managing partner at Launch Financial Planning LLC, notes that pensions are often not adjusted for inflation, potentially reducing purchasing power for retirees.
Strategies to Outpace Inflation
Managing inflation risk in a retirement portfolio can be challenging, especially for investors with limited exposure to stocks and significant holdings in cash or bonds.
Consider the following strategies to mitigate inflation risk in your portfolio:
1. Look at stocks
Historically, stocks have outperformed inflation over the long term, with the S&P 500 delivering around 10 percent annualized returns. Younger investors, in particular, may benefit from the growth potential of equities during inflationary periods, but diversification is key to managing volatility.
Value stocks with strong balance sheets and healthy cash flows are favored by some experts over growth stocks in an inflationary environment. Diversifying with index funds or ETFs can provide exposure to various sectors and asset classes.
2. Consider fixed-income investments
Inflation-indexed bonds, such as Treasury Inflation-Protected Securities (TIPS) and shorter duration bonds, can offer a defensive edge by adjusting payments to account for inflation. CDs and inflation-indexed bonds like Series I Bonds and TIPS are options to consider.
3. Think about your cash
Excess cash in traditional savings accounts is vulnerable to inflation erosion. Consider investing the majority of your funds and maintaining an emergency fund equivalent to at least six months of living expenses. High-yield savings accounts can help offset inflation’s impact on cash holdings.
4. Delay Social Security
Delaying Social Security benefits can lead to larger monthly payments, especially if claimed after full retirement age. The delayed retirement credits can significantly boost benefit amounts and help mitigate inflation effects on retirement income.
5. Start planning early
Being proactive in planning for retirement can help investors better prepare for inflation’s impact on their portfolios. Adjusting goals and cash flow early on can help reduce vulnerability to inflation risks.
6. Consult with a financial advisor
Given the uncertainty surrounding inflation, seeking professional guidance from a financial advisor can help tailor a portfolio to withstand inflationary pressures. Advisors can offer projections, adjustments, and recommendations to align portfolios with financial goals.
Conclusion
Protecting a portfolio against inflation requires a personalized strategy that suits individual circumstances. Whether through growth stock ETFs, inflation-indexed securities, or other investment options, seeking expert advice from a fee-only financial advisor can provide valuable insights and ensure financial plans remain resilient in the face of rising prices.