Inflation in Retirement


Written By: Andrea Bulen, CFP®

Inflation started to creep back into everyday vocabulary in 2021. At first, many economists categorized inflation as “transitory” meaning they thought it was the result of artificially low prices from 2020 and that it would pass quickly. By late 2021, fewer economists were using the term transitory and Fed Chairman, Jerome Powell, said it is time “to retire” the term. Most agree that we will be dealing with inflation for some time. However, just like market volatility, we can’t predict the exact path and there is no magic bullet to solve the inflation puzzle. Although there is no perfect solution, a good first step is to acknowledge that inflation is a risk and review the strategies we can take to control it:

Evaluate Your Expenses

Inflation is a general increase in prices and fall in the purchasing value of money. In order to know how inflation will affect your financial plan, you need to know how much you spend on various goods and services. Not every good and service will be affected by inflation in the same way or at the same pace. By understanding where your spending dollars go and which areas are currently being hit hardest by inflation, you can make adjustments if necessary. This doesn’t mean you need to stop spending altogether, it just means you may make a different choice or delay a purchase. For instance, in our current economy, you may choose to delay a car purchase for a year or two.

In my case, making a different choice resulted in something we enjoyed more than our old choice. Each year we take a family trip to Florida and stay at the same hotel. This year when I went to book a room, I couldn’t believe the nightly rate. The price had nearly doubled from the prior year and pre-covid. I just couldn’t stomach paying that price, but still definitely wanted to continue with our annual family tradition. It took some time, but I was able to find a hotel that was in line, or even less expensive than we had paid in the past. And you know what? We ended up liking the new hotel even more than our old hotel and we’ll be back next year.

Evaluate Your Income

Understand which of your income sources will go up with inflation. Social Security increases should generally keep pace with inflation. For instance, Social Security income increased by 5.9% for retirees in 2022. That is up from 1.3% in 2021, and 1.6% in 2020. It also marks the largest increase since the 7.4% jump in 1983. If most of your mandatory expenses are covered by your Social Security income, you should be relatively protected from inflation. Some (but not most) pensions have an inflation factor. If your inflation protected guaranteed income sources don’t cover most of your expenses, you may be more at risk, which brings us to the next strategy.

Evaluate Your Investment Portfolio – Don’t Get Stuck in Cash

Although it is important to have ample safe assets to moderate risk, too few equities and too much cash can leave your portfolio exposed to inflation. When there is market volatility, follow your investment plan, rebalance and stay invested for the long term. Moving out of equities and into cash can be a major inflation risk.

Plan for the Historical Rate of Inflation

I’ve been in the financial planning industry for 18 years. During most of that time, inflation stayed below the historical rate of inflation that we use in our plans of 3.71%. Clients would challenge me saying, “Why are you using such a high rate of inflation? Inflation is only at 2%. You are artificially making my expenses too high.” The answer: financial planning is just that, ‘planning’. We need to plan for all environments and the reality is that just because inflation wasn’t that high at that moment, chances are there will be economic circumstances to drive it higher. We don’t know what will cause it, but we know at some point it could happen.  Therefore, I always insisted we keep the inflation rate at the historical rate of inflation.  Interestingly, I haven’t been challenged on that point in the last 18 months. Plan that your expenses will rise on average close to 4% per year. It may not be 4% every year, but you never know when there will be a high as it has been last twelve months.

There is no magic bullet to fortify your retirement plan from inflation. However, like most things in life, there are strategies you can take to lessen its impact. Understand your spending and income. Know the adjustments you’ll make if needed and stick with your sensible investment strategy. Shakespeare looks forward to working with you on these strategies in all economic and investment cycles.