Inflation can essentially erode the value of one’s retirement savings during the course of their working years and even during retirement. Understanding the impact of inflation on retirement savings is crucial to building enough wealth to sustain a dignified retirement.
What is Inflation?
Inflation is simply a quantitative measure of the rate at which the average price level of goods or services increases. In other words, it puts a number value on the way in which one dollar, in general, buys less than it did previously.
There are numerous reasons why inflation occurs, from decreased consumer confidence to shortages in the supply of a certain goods or services. The Federal Reserve targets an inflation rate of 2 percent, since cutting inflation down to zero is virtually impossible.
Understanding the Impact of Inflation on Retirement
Decreased Savings Value
Since the purchase value of each dollar is essentially dropping over time, the major impact of inflation is that it makes your retirement savings worth less when you retire.
For example, pretend you’re on pace to have $1 million in your 401(k) in 15 years. Assuming two percent inflation per year, that $1 million will be worth about $738,000 in today’s dollars.
Health Care Costs
Health care expenditures tend to rise as we get older since our bodies simply need more care. Unfortunately, a recent study found that health care costs rose significantly faster than inflation over the last few years.
If this trend continues, it goes without saying that health care will be even more expensive by the time people who are currently working retire.
3 Ways to Protect Retirement Savings from Inflation
There is no single way to completely “inflation-proof” a retirement portfolio, but certain decisions and strategies can help to reduce the potential impact of inflation.
1. Account for Inflation within Goals
When you plan for retirement with a Certified Financial Planner™ professional, be sure to account for inflation. Although the Federal Reserve targets two percent inflation per year, it doesn’t necessarily mean that inflation cannot rise above that level.
It’s recommended that you set a retirement savings goal that is adjusted for a higher inflation rate. It’s better to save more money than necessary than to not save enough.
2. Plan for Health Care Costs
Similarly, it’s also recommended that you anticipate high health care costs in retirement. Since you never know what may happen, it’s important to have a significant savings. If it goes unused, that extra savings could turn into a vacation or a gift for a loved one.
3. Choose Investments that Rise with Inflation
As mentioned previously, there is no investment that is 100 percent “inflation-proof.” However, certain assets, such as S&P 500 stocks and 60/40 stock/bond portfolios tend to beat inflation. Consider incorporating some of these assets in your portfolio.
Understanding the impact of inflation is crucial to reaching retirement savings goals.
