When most people think about inflation, they tend to visualize rapidly increasing prices. Many have experienced the real inflation or rising cost of medical bills, tuition, food, and taxes. However, in general, US inflation is measured by the Consumer Price Index or CPI. The Bureau of Labor Statistics measures a basket of consumer goods. They take the weighted average of any price increases and decreases and publish this rate as the CPI index. If the index is rising, we usually infer that the “cost of living” has gone up.
This level of price increase or decrease has significant ramifications to retirees. If inflation gets out of control or outstrips the earnings capacity of the retiree’s nest egg, then the quality of life for the retiree will decline. For retirees, inflation is best defined as a loss of purchasing power. Take a look at the chart below. We can see that due to inflation, the value of the dollar has declined steadily over the last half century. In fact, the goods and services that one dollar could buy back in 1970, today will only buy $.17 worth.
Not only are rising prices a symptom of inflation, but so are shrinking packages. As manufacturers of goods experience rising costs of ingredients or materials, they normally try raise the cost of the finished product to the consumer to pass along this cost. However, competition may keep these price increases from easily occurring. To combat the squeeze on profit margins, the manufactures will maintain the selling price of the product, but reduce the portions. A good example is the amount of coffee in a “pound” dropping from 16 ounces to 12 in many cases.
Impact of Inflation on Retirement Planning
Retirees need to be planning for longer and longer retirement spans as life expectancies continue to improve. Therefore, even modest inflation levels can seriously erode the savings of retirees. For example, currently, the Federal Reserve is targeting a two percent level of inflation. They want the CPI to increase and hold at this rate. But a two percent inflation rate over ten years will drop the value of a retiree’s portfolio by 25%.
To combat this situation, retired investors need to plan for and take action to mitigate against the detrimental purchasing power effects of inflation. There are many opportunities to do so. One way is to segregate your portfolio by time frames. Short term needs can be invested into more conservative options. However, longer term needs can be invested into a diversified portfolio of equity investments that will grow at a faster rate than inflation over time. Some other inflation protectors are hard assets such as precious metals, commodities, and real estate. Each has its own advantages and disadvantages which can be managed to best meet your inflation protection goals.
At Geier Asset Management, we have studied the effects of inflation on our clients’ portfolios and have formulated some very attractive strategies to combat the drop in purchasing power. We can help you plan a successful retirement income approach that will alleviate the harmful attack on your quality of retirement life from inflation.
© Geier Asset Management, Inc. October 2015. Thomas M. Geier is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Geier and not necessarily the firm. Any advice given is general in nature and investors must consider their own individual circumstances. Past performance is no indicator of future performance. The firm makes no warranties or representations of any kind relating to the accuracy or timeliness of the information provided.