Inflation and Your Retirement Account
One of the goals I have for my blog articles is to help educate you on the basics of investing and managing your portfolio. In my opinion, education is the most effective way to gain the knowledge necessary to appropriately and successfully prepare for retirement.
Recently, we have been hearing the term inflation and I thought I would explain why inflation is so significant, and how it relates to your retirement portfolio.
Inflation, simply put, is the rise in prices of goods and services and the loss of purchasing power of your money over time. This means that your savings in today’s dollars will not be able to purchase as much tomorrow as you are able to purchase today. For example $20 in 2008 has the same buying power as $7.53 in 1980 and $20 in 1915 has the same purchasing power as $433.30 in today’s dollars! History shows that inflation has averaged approximately 3-4%a year. For example, prices rose an average of 2.4% in the 1960’s, 6.7% in the 1970’s, and 5% in the 1980’s. (www.bls.gov)
Inflation represents the minimum return you must generate with your investments to maintain the “value” of a dollar you have today for when you spend it in the future. Let’s say inflation is 3% a year. In order to purchase what you can today next year (disregarding non-inflation related price increases) you need to generate a minimum of 3%. Taking it a step farther and you’ll find that inflation also affects the “real” return generated by your investments. If you have a mutual fund that generated 8% in a year with 3% inflation your real return is 5%.
We cannot predict what inflation is going to be in the future but when you choose your investments, you will always need to consider the long-term effects that inflation will have on your returns. The impact of inflation on your portfolio depends on the type of securities you hold. Everyone, no matter if you hold all cash or all stocks, is affected by inflation. Individuals living off a fixed income are typically the most affected by inflation (they receive the same amount per month which in turn purchases less and less as time goes by) while individuals with exposure to the stock market theoretically are the most likely to have investments that exceed the rate of inflation and as a result have the ability to purchase more with their invested dollars.
Inflationary risk is just one of the many risks associated with investing and unfortunately, it is often overlooked when assembling a retirement goal or plan. I’ll try to continue to cover the areas I feel are important for individuals to be aware of, but if you guys have any that you’d like to know more about please let me know by posting a comment to this post of by sending an email to info@smart401k.com. And as always, please feel free to contact us by phone or email if you have any questions that you’d like to address on a one-to-one basis with myself or another one of our advisors.
Jessica Slaters, Investment Advisor
