Inflation can be a real problem in retirement. It has been called the “silent killer” of personal finance because it slowly eats away at purchasing power and your ability to buy essential goods in the future – even if you save. To understand this concept, consider the lesson we can learn from a cup of coffee.
Say a cup of coffee costs $1. You have a dollar in your pocket. You can buy the cup of coffee now and it’s exactly within your budget.
On second thought, you consider another option – saving that dollar. You put it aside at 5% interest assuming that you will be in good shape to buy that coffee the next time around. If you decide not to buy the coffee and put that $1 into savings earning 5%, in one year you will have $1.05.
But in one year you go to buy the coffee and it now costs $1.10. While you earned 5% interest, coffee prices went up 10%. You prudently saved your money, but instead of coming out ahead or even keeping pace, now that cup of coffee is no longer within your budget. Because of inflation, your savings just wasn’t enough.
The Rising Cost of ‘Things’
It’s a small example, but it illustrates a common financial threat that affects many people, especially those whose wages don’t increase and/or who don’t invest properly. Over time, costs increase and everything becomes less and less affordable.
This simplified example of inflation makes a necessary point: If you are not outpacing the increased costs of “things,” you will find that you are able to buy less and less over time.
That may not be detrimental if those things are handbags, golf clubs, new TVs or other discretionary items. However, if things like food, shelter, and health care become unaffordable, which they have for many, you have a real problem on your hands.
How to Combat Inflation
The lack of wage inflation over the years has been a factor in the squeezing out of the middle class. Tackling that issue is not within the scope of this personal finance blog, but how best to manage your finances to combat inflation is.
Unless you are wealthy or spend very little and can afford to have a negative real return, year after year, it is necessary to build a portfolio that can outpace, or at least keep pace with inflation, especially in retirement.
The Volatility / Risk Trap
Many people fall into the trap of associating volatility with risk. When they get close or into retirement, they put 100% of their investments into cash or cash-like investments. That may work for some, but it would work only for those with large sums of money and/or very few expenses.
Most people need some growth in their investments to stay ahead of inflation, and that is going to require a portfolio of diversified asset classes. Diversification provides the best opportunity to afford the necessary, and maybe even a few unnecessary things in life, even 20 or 30 years into retirement.
If you enjoyed this post and would like to see more, follow the Unbroke Facebook page.
In you enjoyed this post you may also like: