July 08, 2021
After more than a decade of hibernation, inflation is back in our lives.
Ever since the financial crisis, prices in general rose less than 2% a year on average. That may have lulled many of you into not worrying about inflation. But the latest reading showed the overall inflation rate rose 5% annualized.
There’s good reason to expect that this recent spike in inflation is temporary, as businesses are finding it hard to meet the demand of consumers ready to spend as the economy emerges from the pandemic shut down.
But nor is it expected that we will go back to the days of super-low inflation. In a future where inflation could well return to 3% or so—its long-term norm—I want you to make sure your retirement savings strategy is built to withstand inflation.
Plan on many costs being double what they are today. A 3% annual inflation rate might not sound so bad, but if you compound that 3% every year for 25 years, it means that what costs you $100 today will cost you more than $200 in 25 years.
If you are 35 and saving for retirement, you need to deal with that reality. If you are 65 and living in retirement, you need to deal with that reality.
Keep investing in stocks. Over the long-term stocks have produced the best gains after factoring in inflation. Bonds and cash struggle to keep pace with inflation; only stocks have a track record of earning more than inflation.
That said, stocks also go through periods where they lose value. Your retirement portfolio always needs to take that into account. If you are young, you have time to ride out bear markets for stocks, but if you are older, you likely will want to keep less invested in stocks than when you were 20, 30, 40, 50 years old. One rule of thumb to help you think through your right mix of stocks and bonds/cash: subtract your age from 100 (or 110 if you are in good health and other members of your family have lived into their 90s). That’s how much you might consider keeping in stocks.
Get the most out of Social Security. Social Security comes with an annual inflation adjustment. This is known as the Cost of Living Adjustment (COLA). For 2021 it was 1.3%. Next year it could be 5% (we won’t know for a few more months).
What’s so important to understand is that it’s not just people who are already getting a Social Security benefit who are credited with the COLA. Once you turn 62, the COLA is added to your benefit, even if you are delaying starting to collect. By now you know I think delaying Social Security as long as possible is a smart move if you are in good health in your early 60s. That’s because between 62 and 70 Social Security pays you to wait. Each month your eventual benefit increases. That’s the “delayed” credit. But you also get the COLA for those years as well. That adds to the value of your eventual benefit.