Inflation (aka “Purchasing Power Risk)
Increases in the cost of living can erode the value of your money, and more importantly – the goods & services that you can purchase with that money.
This is known as inflation – where the money you have loses value over time.
Inflation is also particularly problematic for retirees who are generally living on a fixed income and may have a life expectancy of 20-30 years after retirement.
Let me introduce you to Sharri – who retired at the age of 60. At that time, she was pleased with her retirement income. She was receiving a $1,200 per month pension, and $1,500 per month from money that she had invested in long-term bonds.
Her expenses were only about $2,300 per month, so she was even able to save a little bit of money from that income to enjoy experiences and take the occasional trip.
Fast forward 15 years. Sharri still receives the $1,200 per month pension, but now she gets only $900 per month of interest income, which comes from certificates of deposit and money markets.
You see, she bailed out of bonds after losing sleep over the sometimes roller-coaster-like price movements in the bond market.
And over the years, due to inflation, her monthly expenditures have risen to about $3,600.
Thankfully, she began receiving social security at age 65 and is receiving $1,250 per month. But with a total shortfall of almost $400 / month, she is now forced to dip into her principal (original capital or investment money).
The result? Sharri is terrified of outliving her resources.
Sharri has reason to worry. She has 100% of her money invested very conservatively, with no protection against the ravages of inflation. Although her income felt very comfortable in the early years of retirement, it doesn’t at age 75, and Sharri may easily live another 10-15 years.
The erosion of purchasing power of your spendable dollars can, over time, be just as bad as a major market crash.
As a financial advisor, I often see skittish investors trying to play it super safe by keeping ALL of their money in bonds, CDs, and money market accounts, thinking that that is the smart thing to do.
The risk in this strategy is that your money won’t grow over the years to accomplish your goals, or to keep up with the pace of inflation.
You’re going broke slowly!
I often espouse the advantages of utilizing cash value life insurance and fixed indexed annuities as tools to reduce risk and to provide reliable income (“to kick off cash flow!”) Because these products have no risk of market loss, their distribution rates can be much higher than that of traditional market investments.
But with that said – over a long-term time horizon, those vehicles will likely lose their purchasing power – which is why those programs are only 1 “bucket” of money in a holistic retirement plan.
In order to combat the loss of purchasing power due to inflation, it’s really important to have a separate “bucket” of money positioned for growth in the equities market. And even though some investors may be skittish, the good news is that we set up the plan in a way where the income produced from life insurance, annuities, pension, etc. are enough to cover your expenses early on in retirement.
That way, we don’t have to rely on the investment bucket in the event of a market crash (we know that the market can be volatile in the short term).
We let that bucket of money grow over time, untouched – for 6 years, 8 years, maybe 10 years – and when we are happy with the growth in that bucket, we sell, take our profits, and use those profits to bolster our fixed income sources that have lost purchasing power due to inflation.
And then we simply do it again over the next 5–10-year cycle. And then again. Rinse, wash repeat. Using this strategy, we are managing market risk AND inflation risk – at the same time!
If you lean to the extremely conservative side as an investor, I hope this article has shown you that there is a spot in your retirement plan for stock market investments, and it plays a very important role – to offset the ravages of inflation.
Ronald A. Sneller, Jr. FICF, FSCP®, RICP®, RFC®
Registered Financial Consultant
Investment Adviser Representative
Ron Sneller is a fee-based financial consultant. A veteran of the financial services business for 10 years, he’s helped clients with their mortgages, insurance, investments, and retirement planning during that time.
Through education, empowerment, and action, Ron helps his clients take back control of their financial life to give them more clarity, focus, and security. You can reach him at: ronald.sneller@snellerfinancial.com
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