How does inflation affect retirement savings? Is there anything that you can do to shield your retirement savings from being eaten into by inflation? Join me in yet another interesting article in which we shall be talking about one of the worst enemies your retirement savings are bound to save if you do nothing to save them. Read on to discover what you are up against, and what you can do about it.
People often think that their retirement savings plans are safe from inflation, but they really aren’t! Over the last 30 years, annual inflation has averaged about 3%. It is quite surprising that we do not give inflation the due attention for all the damage that it does to our money held in savings and investment accounts.
Inflation gradually leads to the gradual increase of the prices of goods and services, meaning that your money may after a long time not be as useful as you think it will be. To put this in context, if inflation occurs at the rate of 3% in 2021 and 2022, you will have to spend 6% more on goods and services in 2023.
This means that if you are purchasing a big-ticket item today at $1000, it will cost you about $1060 in 2023. Inflation eventually leads to the doubling of the prices of goods and services. If you assume that your retirement savings are intact, then you will only be surprised later on to only have half the spending power when inflation has thoroughly eaten into them.
How does inflation affect retirement savings?
Here are the three main (but not only) ways in which inflation affects your retirement savings
It erodes the value of your investments and savings
If you are amongst those who are placing huge stashes of money in your investments and savings accounts for your retirement years, then you should be aware that the forces of inflation will effectively reduce their value gradually.
Say for instance you save $5000 per year for about 30 years, with an average rate of return of about 7% per annum, you will end up with about $505,365 at the end of this period. Who would not want to have about half a million dollars in their account after about 30 years? I bet no one.
Unfortunately, due to the force of inflation, the future value of your savings will be equivalent to $208,204 in savings today. You will, as such, be in possession of a huge amount of money, but it will purchase less than it can do today, owing to the force of inflation.
Simply put, the cost of prices and goods will be gradually rising due to inflation, hence you need to meet the extra charges in future.
The cost-of-living adjustments for social security barely keep up with the rate of inflation
Social security benefits are also affected by inflation, which is something that is unknown to many people. Inflation is actually one of the main reasons why social security benefits have to undergo cost-of-living adjustments referred to as COLAs. While the COLAs are perceived as a good thing, they often underestimate the rate of inflation, more so for the seniors. The Social Security Administration usually measures the price changes each year, by considering the Consumer Price Index for Urban Wage Earners and Clerical Workers, popularly abbreviated as CPI-W. It proceeds to determine whether a COLA is necessary, and to what extent it is necessary.
The CPI-W, unfortunately, underweights certain sectors that have very steep price increases. For instance, healthcare expenses have risen steeply. One example is the cost of prescription drugs that has risen by more than 190% from 2000. As a result of such underweighting, the purchasing power of social security has actually dropped by more than 34% despite the adjustments. This means that those relying on Social Security to manage their retirement should do something about the situation.
Investment choices do not factor in the force of inflation realistically
Most people who realize that inflation is affecting Social Security often turn to investments such as Bonds and CDs. The yields and interest rates of these instruments have unfortunately been under 2%, leading to a negative rate of return once inflation is factored in.
Stocks happen to be some of the few investments that outpace inflation- they have actually had average returns of about 7% over time. Stocks, however, have their downsides.
Most investors are often advised to place a portion of their funds in fixed-income instruments such as CDs and bonds, since such investments are less volatile than stocks, and are perceived as a go-to option during economic downturns. I, however, doubt that they would stand a chance against assets whose value increases during an economic crisis.
What can you do to protect your assets from inflation?
The solution to the inflation problem is often presented as diversification. Many investors, however, diversify their assets in the wrong way. You will for instance find some investors buying different types of stocks hoping that they will go through economically challenging times unscathed. Unfortunately, inflation and other forces of the market do not discriminate against stocks. If a stock market crash happens today, rest assured you will be singing the hymn “It is well with my soul”- you will lose a great portion of your retirement investment funds.
True diversification only happens through the allocation of funds to different asset classes, in different industries. Even so, you need to have assets whose value increases during economically challenging times, and that can withstand the forces of inflation. All factors considered, the one asset that meets these requirements effectively is gold. Not just any type of gold will do- you need to have some physical gold since owning gold in the form of paper assets will expose you to forces of the market such as inflation. Having about 5% to 15% of your retirement savings allocated to physical gold is one of the only ways you can guarantee your peace of mind during an economic crisis, and when the pace of inflation is alarming!
If you had a $10-dollar bill in 1917, it would get you a good pair of shoes. In 2021, however, you may only purchase a low-quality pair of shoes, that may not proudly wear when outdoors. If you owned gold worth $10 back in 1917, it would get you the same pair of shoes that the person who had a $10-dollar bill purchased.
In 2021, however, the gold that was worth $10 is now worth more than $500, which is enough to get you several high-quality shoes.
I hope that this example shows you how exactly gold shields you from inflation.
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That will be all for this article in which we have answered the question, “how does inflation affect retirement savings?” I hope that you found it helpful, and that will act upon the information presented today. Let me know if you have any questions about this topic, and whether you need help finding your way in the gold investment industry.
I wish you well,
Eric, Investor and Team Member at Gold Retired!