Help CenterInflation is making the headlines. In retirement, inflation is particularly perfidious. If you are in retirement, inflation can eat away at your quality of life. For working people, at least there is hope that future income increases will keep pace with the cost of living. But for retirees, they don’t have a salary. How do retirees stay ahead of inflation?
When we face a large problem like inflation, we break it down to absolutes. And then, the answer becomes much easier. Inflation means that every year we live, nearly everything we buy gets more and more expensive. To solve for this, we need an income that increases at the same pace, or faster than, inflation.
Bonds, Annuities and fixed income investments
Many retirees love a fixed income. In fact, many retirees chase after high-income investments and hope they are also low-risk. This is a great myth—the truth is more sanguine, because the higher risk, the higher the potential return. Can a retiree depend upon bonds, annuities and other fixed income investments for retirement income?
When we purchase a bond, we receive an income that is secured by the quality of the company or government that issues the bond. We invest a lump sum, called the principal, and the issuer sends us regular fixed income. The income, by definition, does not increase with inflation because it is fixed. Over time, the value of that income decreases by the rate of inflation.
An annuity provides a fixed income guaranteed by an insurance company. We buy the annuity and the insurance company makes payments, usually for life. With some annuities we must defer the income start date until later. In many cases, the annuity income can be higher than a bond or other fixed income investment, especially if we have to wait to start income at a later date. In an annuity, we transfer the investment risk to the insurance company. The insurance company takes the risk that if the principal were ever to go to zero, they would continue to make payments to us “annuitants.” But inflation eats up a lot of the income over a lifetime. So be wary of depending too much, if at all, on annuities to provide income for a long retirement.
Fixed income investments, like bonds and annuities, are appealing because the principal is more secure. But over time, the quality of our life decreases if the quantity of income we receive decreases on an after-inflation. We do not want to be dependent on only fixed income in retirement.
Investing in equities, aka the stock market, in retirement
Investing in the equity of companies provides an opportunity to stay ahead of inflation. The value of the companies have increased faster than inflation rates. Many companies provide dividends, which are income for the owner, and dividends have increased at rates that exceed inflation. (sources below)
The risks of owning equities in the retirement years is that we might be prone to selling them when the market is down. Equities share prices go up over long periods of time, but over any short period of time, you may be looking at a decline. Successful equity investing aligns ownership timeframe with retirement timeframe, or longer. In other words, own stocks for the long haul. Stay invested and do your best to ignore the short-term volatility of the equity prices. Remain confident in the long-term upward-sloping trend of equity growth.
Inflation is a self-fulfilling prophecy
“To reduce inflation, you have to squash the perception that we are going to have it.” – Eddy Vataru, Osterweiss
Inflation is a self-fulfilling prophecy. If we believe prices will be higher, then producers keep prices higher, and this positive cycle continues. Higher inflation may continue for many years into the future. However, our investment experts do not believe that record-high rates of inflation will continue. Instead, things will continue to get more expensive, at maybe 3% per year. Compare this with the past decade where inflation averaged (historically low) 2% per year. In our financial planning forecasts, we default to a 2.5% inflation rate expectation. We make a forecast for the growth of our investments. We then calculate what kind of an income our clients are likely to be able to safely pull out of their investments.
Related articles
For more information on how to safely manage investments in retirement, make sure to read more about inflation:
- How Inflation Affects Investments | A&I Wealth Management
- A Billionaire’s Take on Inflation | A&I Wealth Management
Some related services we provide:
The Fed’s Limited Power
A lot of us read and hear about the Federal Reserve. But many of us do not understand one of the key reasons why the Fed has limited power. Our research partner, iMGP (iM Global Partner), describes the limits well:
“The Fed’s basic toolkit involves raising rates to suppress economic activity, with the resulting lower demand leading to lower prices. However, the problem is that this simple cause and effect assumes the supply side of the economy remains steady.”
In the aftermath of Covid, Russia invaded Ukraine, and this one-two punch created supply chain problems throughout the world. Soon thereafter, the US government and many other governments around the world issued more currency. And then came rates of inflation that we had not seen since the 1980s. During this timeframe, equities continued their upward trend at a pace that exceeded the rates of inflation.
In retrospect, the Fed may have brought about a soft landing after the Covid crash. This topic is politically charged, however, and the answers are never clear-cut. Instead, some timeless advice for retirees may be helpful. The Fed is a referee, not an athlete. They may call the shots but the companies, the investors, the public must play the game. We may disagree with the referee’s decision, but we all play by the same rules, and no one (to my knowledge) has ever won a game by blaming the ref.
Today, retirees face inflation risks. It is important to align the investments so they overcome the risks that are most important, over the long term.
Inflation’s Effect on Equities
When investing in equities, it is important to stay humble and diverse. We do not recommend reallocating a portfolio in anticipation of inflation, interest rates or predictions about the Federal Reserve. Inflation’s effect on companies is different, depending on countless factors, almost all of which are outside of a retiree’s control.
Again, from iMGP:
“Generally speaking, higher [inflation] rates favor stodgier value stocks over high flying growth stocks because the valuation of growing companies is driven by future earnings. When those earnings are discounted back to present value at a higher interest rate, the present value is lower. Companies more reliant on increasingly costly raw materials may suffer relative to those that are not. Companies carrying higher debt loads are more apt to be hurt by higher borrowing costs.”
In Summary
Inflation may last a while. The Federal Reserve has only limited ability to control rates. There may be different investment opportunities for all of us as we navigate a higher inflation world. For the complete report, contact your financial advisor!
Source: Disclosures – A&I Wealth Management
How does a self-made billionaire invest to stay ahead of inflation?
Baron Capital is one of the investment managers we use for a large number of client portfolios. The founder, Ron Baron, has a gift. He makes complicated concepts easy to understand. Plus, I kind of like his sense of humor. Hopefully you do too! Here is Ron’s take on inflation during his lifetime. What is your perspective? Read more in our blog: Ron Baron’s Take on Inflation | A&I Wealth Management
How does inflation affect retirees differently than working individuals?
Retirees typically rely on fixed income sources rather than wages. As prices rise, their purchasing power declines unless their income increases at the same pace as inflation.
Are bonds and annuities safe from inflation risk?
Bonds and many annuities provide fixed payments that do not automatically increase with inflation. While they may offer stability, their real value can decline over time if inflation rises.
Should retirees invest in stocks to fight inflation?
Equities have historically grown faster than inflation over long periods. Many companies increase earnings and dividends over time, which can help retirees maintain purchasing power. However, stock prices fluctuate in the short term, so proper allocation and time horizon matter.
What is a safe withdrawal rate during inflationary periods?
Safe withdrawal rates depend on portfolio composition, inflation assumptions, and life expectancy. A comprehensive financial plan typically models inflation expectations and adjusts income strategies accordingly.
Can the Federal Reserve fully control inflation?
The Fed influences inflation primarily through interest rate policy. However, supply chain disruptions, global events, and fiscal policy also affect inflation, limiting the Fed’s control.
How can I build an inflation-resistant retirement plan?
Diversify across asset classes, include long-term growth investments, maintain disciplined withdrawal strategies, and coordinate tax planning. A comprehensive income strategy is more effective than relying solely on fixed income products.
Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as financial or legal advice. Please consult with a qualified professional for advice regarding your specific situation.
DISCLOSURE: Client stories included in this blog reflect hypothetical client situations that represent those commonly encountered by AIWM representatives.