Retirees, who are already grappling with the effects of stock market volatility, now face a potentially bigger threat to their financial security: inflation.
Indeed, the price of consumer goods and services hit a 41-year high in the first half of 2022, putting pressure on the central bank to raise interest rates repeatedly in an attempt to cool off the overheated economy.
Inflation hits us all in the form of higher prices for food, gas, and groceries, which diminishes purchasing power. (Learn more: What should investors do about inflation?)
But retirees and those nearing retirement feel a special kind of sting as inflation takes hold. Why? It erodes the value of their savings and increases the likelihood that they could outlive their assets.
“Having the ability to combat inflation is not only important from a Federal Reserve level, but also important in a personal plan,” said Paul Tokarz, a financial professional with WestPoint Financial Group in Chicago, Illinois. “If your retirement income does not keep pace with inflation, your purchasing power will be impacted and your ability to provide for yourself and those who count on you would also be impacted. The pressure this would put on your portfolio could impact the longevity of the portfolio itself — which is never good.”
While there’s nothing retirees can do about economic forces, financial professionals say retirees and those on the cusp of retirement can act now to insulate themselves against the effect of rising prices.
Such steps include:
- Maintain a diversified portfolio
- Consider annuities
- Pay down debt with home equity
- Delay Social Security
Despite the downside risk that inflation presents, many near-retirees don’t seem to know how higher prices might affect their financial well-being. A 2022 MassMutual survey found that more than half (54 percent) of pre-retirees ages 55 to 65 were unclear whether their retirement income plans accounted for either inflation or market volatility.
For historical context, inflation surged to more than 13 percent from 1965 to 1982 in a macroeconomic period known as the Great Inflation. It fell quickly in the early 1980s after an aggressive interest rate campaign and easing of the global economic recession at the time. Since then, inflation has been low to nonexistent until late 2021 when ― amid a combination of rising labor costs, aggressive government stimulus, and ongoing supply chain challenges caused by the COVID-19 pandemic ― prices started rising again.1
Maintain a diversified portfolio
When it comes to combating inflationary pressure, the good news is that many retirees and pre-retirees are already putting their best foot forward by maintaining a diversified investment portfolio.
Stocks, of course, can be volatile and offer no guarantees of future returns, but they have historically been a reasonable hedge against inflation. Why? Because companies can usually pass higher production and labor costs along to consumers.
“A diversified portfolio is really the best hedge against inflation,” said Gregory Olsen, a financial professional with Lenox Advisors in New York, noting that a well-balanced portfolio can mitigate downside risk because it’s more likely that a portion of your portfolio will zig while the rest of it zags. “We are all reactionary. Three months ago, we were focused on the war in Ukraine, and a year from now we may be talking about how to position your portfolio against some new macroeconomic threat. I don’t know what’s next and I’m not about to make that prediction, but I do know that if you have a diversified portfolio, some part of it will likely benefit from every economic trend.”
A diversified portfolio would usually include a mix of stocks and bonds. More sophisticated investors may also have holdings in specific industrial sectors or commodities, like gold or oil, typically through dedicated mutual funds or exchange-traded funds.
And some experienced investors may diversify further still by looking at alternative ― albeit riskier ― investments, such as private equity, cryptocurrency, or even collectibles and artwork. Real estate is also sometimes used to diversify a portfolio, particularly real estate investment trusts (REITs), which are companies that own or finance income-producing real estate across property sectors.
All asset classes ― from Treasury bonds to blue-chip stocks to commercial real estate REITs ― involve different levels of risk. Any allocation to such investments should take into account an investor's age, tolerance for risk, and unique financial goals. A financial professional can help you decide on a portfolio mix that’s right for you.
As investors approach retirement, many shift to a more conservative asset allocation that reduces their exposure to stocks. But financial professionals say retirees should resist the urge to become too conservative with their portfolio. Many will live 30 years or more in retirement and may need exposure to equities to produce returns or at least offset the corrosive effects of inflation.
The bond market has suffered historic declines in recent months, making them less attractive as a fixed income security than they already were. Indeed, MassMutual Chief Investment Officer Daken Vanderburg noted investors should prepare for “lower near-term performance” in fixed-income markets.
While Treasury inflation-protected securities (TIPS), a type of U.S. government bond that is indexed to inflation, may seem like the obvious bet in an economy marked by rising prices, they can be unpredictable.
Olsen suggests retirees stick to more conventional fixed-income securities. Those who wish to balance their equity-heavy portfolios, for example, may look to municipal bonds, which generate interest income that is free from federal taxes and often state taxes as well.
“Yields have come up a lot, so investors may want to consider municipal bonds because of their tax-free nature,” he said. “Even though most retirees are in a lower tax bracket than they were while working, some remain in an elevated tax bracket because they are taking required minimum distributions from their tax-deferred retirement accounts.”
Many retirees might be able to further insulate their portfolio from the effects of inflation with a combination of annuities and whole life insurance, both of which offer income guarantees.
Annuities are insurance contracts that guarantee a fixed income for as long as you live, either starting immediately or at some point in the future in exchange for a lump-sum payment or series of payments. (Learn more: Types of annuities and how they work)
There are three primary types of annuities: deferred fixed, deferred variable, and income annuities. Fixed annuities guarantee that you cannot lose either your principal or any interest that the annuity accumulates. (Learn more: Does an annuity fit your retirement goals?)
“Annuities that have guarantees of zero loss of principal have been great at this time to help combat the overall economic situation today with equities and fixed income,” said Tokarz. “However, cash value life insurance, cash on the sidelines, pensions, real estate investment income, and other alternatives give retirees the cushion to allow their investment portfolios to cycle through losses and bounce back without selling and capturing losses. The only way to do that is to have alternative positions.”
Here again, a financial professional can help you determine whether annuities are right for you. (Related: Taking cash off the table with life insurance and annuities)
Pay down debt with home equity
While inflation is typically perceived as an economic evil, Olsen points out that it can actually benefit some.
“If you are a renter and your cost of rent is going up, or you were waiting to buy that retirement home in Florida where prices have surged, higher inflation is a bad thing,” he said. “But if you’re a homeowner and all of a sudden your house has appreciated 50 percent, that’s very good. Inflation will help some people and hurt others.”
Retirees with a highly appreciated 5-bedroom home in the suburbs who no longer need the square footage, he said, may choose to capitalize on the current market and downsize to a smaller home. The profit from the sale of their home can be used to pay off debt, invest for growth, and minimize longevity risk (or the risk of outliving their assets).
Delay Social Security
Social Security — the federal insurance program that provides benefits to retired people, the unemployed, and individuals with a qualifying disability — is an important source of income for most retirees. It can also be a powerful two-pronged tool to combat rising prices.
For starters, Social Security benefits are adjusted for inflation through cost-of-living adjustments.
Retirees also have an opportunity to permanently increase the size of their Social Security checks (and effectively give themselves a raise) by delaying the start of their benefits.
Those who are eligible for Social Security can begin claiming benefits as early as age 62, but they won’t receive the full amount to which they are entitled until they reach their full retirement age — which is either age 66 or 67 depending on the year they were born.
By collecting benefits early, they accept a permanently reduced benefit for life, which reflects the additional years they are likely to collect.
Conversely, they can permanently increase their monthly benefit by up to 8 percent per year by delaying Social Security benefits beyond their full retirement age until they reach age 70 when the advantage of delaying any longer disappears. (Learn more: When should I file for Social Security retirement benefits?)
Those who can afford to delay benefits by even an extra year or two can offset some of the effects of inflation and stretch their savings further.
Inflation may be trending higher, but retirees who stay diversified and create a plan to mitigate risk can help ensure that their savings keep pace with rising costs. A financial professional can help.
“If 2022 has taught us anything, it has reinforced why overall financial planning is not just typical investment portfolio management, but truly looking at the entire picture and making sure you have options,” said Tokarz.
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1 U.S. Bureau of Labor Statistics, “Consumer prices up 8.5 percent for year ended March 2022,” April 18, 2022.