Broker Check

Inflation and Income in Retirement

February 06, 2023

Having spent the last several years in a relatively low inflationary environment makes it difficult to adjust to the new, higher cost era that we find ourselves in today. It is like taking a warm shower and you are shampooing your hair when the hot water runs out! Ok, perhaps a bit harsh of an analogy but that’s what it seems like most days when I go to the grocery store and get a sticker shock when I’m buying my organic greens, a bit of my favorite cheese and a half gallon of almond milk.

As the world copes and adjusts to the new inflationary environment, what tends to be undermined is the impact of higher inflation on consumers’ purchasing power over a longer period of time. While preparing financial plans for clients, as a measure of prudence, our firm has always used higher than normal inflation rates to project future value of cash flows. This was simply from the belief that lower inflation rates were not going to be sustainable over the long-run, especially considering the monetary easing that we have enjoyed for so many years. And yes, it has caught up with us and then some, exacerbated by the not-so-normal conditions from the pandemic our economy has had to, and continues to, endure.

The long-term impact of inflation on an investor’s purchasing power is like a frog in boiling water. It is uncomfortable but tolerable, until such time that it becomes impossible to sustain and afford the bare minimum necessities of every day life.  And this leads me to why holding excess funds in cash over many years with no growth does not make sense. But that’s a discussion for another day.

Social security benefits tend to constitute a large chunk of American retirees’ income, and while those benefits have been receiving cost of living adjustments (8.7% in 2022), the funding of Social Security Trust has been at risk. Currently, the Social Security Board of Trustees project benefits to be reduced by as much as 75% by the year 2035 if substantial legislative measures are not taken to offset the bleed. And given the state of congruency (or lack of?) in our Congress, who knows when that will come to fruition.  

So where does this leave the average investor? And what is one to do?

The first and most important step is creating a budget, and tracking spending. Building a rainy-day fund to offset unforeseen expenses is ever so important to do today. But here is where most retirees or soon to retire individuals fall short: they don’t project what their future income and expenses will look like given the anticipated economic environment. It’s an estimation of sorts that falls short in a significant way. It is important to understand the compounding effect of persistent and tenacious inflation on one’s income. Perhaps working a year or two more will help further build the retirement nest egg or cutting back on some home improvements or even travel plans may help.

December inflation (CPI) measure came in at 6.5%, much lower than June 2022 which was upwards of 9%. At the rate with which inflation growth is reducing, it is expected to hover around 4% by the end of 2023. There is also a good chance that the Federal Reserve is over-shooting their target and may be lowering interest rates in the next 12 to 18 months. But until that happens, it would be prudent to take caution and be judicious.  Worse case scenario will only help investors’ bottom line in the end.