Most people have a basic understanding of how inflation works. When the prices of goods and services rise, your money doesn’t stretch as far. During your working years, if you’re receiving regular pay increases, it can be easy to overlook inflation’s overall impact on your bottom line because those raises can help to offset the effects of rising prices.
But what happens when you take a long-term view of inflation? You’ll notice that the prices of everyday goods have significantly increased over the years. Take a look at this inflation graph, which tracks inflation for the 10-year period from 2005 through 2015.
The graph of inflation rates displays annual rates from 2005 – 2015. Rates of inflation are calculated using the Current Consumer Price Index published monthly by the Bureau of Labor Statistics (BLS). For the most recent monthly data (12-month based) is used in the chart and graph. Source: UsInflationCalculator.com
In the chart above, price changes are measured by the U.S. Department of Labor’s Consumer Price Index (CPI). The CPI provides an estimate of a price change between two periods of time for a sampling of goods people buy for day-to-day living. It represents the degree to which prices change between these two points of time. (Interestingly, it does not measure the change in prices of food or energy.)
Can Your Retirement Income Do Two Important Things?
Once you’re retired, inflation can pose a big threat to your budget, since most people are only taught how to live on a fixed income. When you’ve left the workforce, your retirement income will need to do two important things: last for your lifetime and fully cover your expenses during retirement. But here’s why you may find it difficult for your retirement income to achieve both of these goals:
Social Security is designed to last for your lifetime and can provide a cost-of-living adjustment (COLA), but this adjustment is not guaranteed to happen each year – for example, there was no COLA in both 2010 and 2011. (The Social Security Administration uses the CPI-W to help determine the amount of any COLA that is granted to Social Security recipients.)
The longevity of your other retirement income sources will depend on how much your investments earn (investment earnings can be unpredictable and your investments may lose value) – and the amount of money you withdraw from your retirement account(s) each year. (Too high of a withdrawal rate may mean you could run out of money during your lifetime.)
Creating Your Retirement Income Strategy Today
There are several steps you can take to help yourself counteract the effects of inflation – and help you to ensure that your retirement income will last. These include:
Developing a diversified investment strategy by investing some of your assets into a mix of stocks (“equities”) and fixed income funds. Over the long term, equities have tended to outpace inflation (more so than fixed income investments), but stocks tend to have a higher level of investment risk than fixed income investments, such as bonds.
Following a distribution/withdrawal plan by withdrawing some of your assets at certain points in time. This can help you lengthen the life of your assets, gain the potential benefit of compounding growth and help you systematically increase your retirement income. Purchasing financial products, such as annuities, which can provide guaranteed payments for life.
Speak with Your Financial Professional
Having a guaranteed source of lifetime income may give you the confidence and ability to enjoy retirement the way that it should be enjoyed — doing the things you love without the worry of outliving your money. So, be sure to speak with your financial professional about the steps you can take to help secure your retirement income.