Are You Factoring Inflation into Your Retirement Planning?


Inflation is ever-present and something we all have to live with. Yet when talk of retirement planning comes up, inflation barely rates a mention. Maybe it’s because inflation has been low in recent years, so we think that it doesn’t make that much difference. Or perhaps it’s because if we do fully recognize the effects of inflation on retirement planning, future projections look a lot less certain.

Retirement Portfolio Projections Can Dazzle, However . . .

Let’s say that you’re 35 years old, you earn $60,000 per year, and you decide that in order to have a comfortable retirement you’ll have to earn $40,000 per year from your retirement portfolio. Assuming a safe withdrawal rate of 4% per year, you will need a $1 million for retirement portfolio by the time you turn 65.

With 30 years to prepare for retirement, and assuming an 8% average annual rate of return on your portfolio, you find you can get to the $1 million mark by saving just 10% of your annual salary. One million dollars by saving 10% of your pay each year – that’s pretty good!

But not so fast.

What Inflation Can Do to a Retirement Portfolio

When we look at “little bit of inflation” it’s often easy to underestimate or even ignore its consequences. It may not make a difference if you’re planning only a year two out, but if you’re making plans for decades into the future it will be a factor – a major one.

In our example above, we’re looking at retirement 30 years out. What effect will an inflation rate of just 3% have on those plans?

3% inflation over a 30 year period will mean that it will cost $2,427 to buy what $1,000 pays for now. If we apply that conversion to our $1 million retirement portfolio, the portfolio’s purchasing power in 30 years will be a little below $400,000. You probably won’t be able to retire on that much money, at least not the way you hope to.

A 3% rate of inflation isn’t arbitrary either. It’s actually the average rate of inflation over the most recent 30 year period, from 1982 to 2012, according to the Bureau of Labor Statistics Inflation Calculator.

How to Compensate for Inflation in Your Portfolio

If you are basing your retirement projections on straight portfolio performance you’ll need to adjust your strategy in order to compensate for inflation. Depending on your age that may mean that you’ll have to double or even triple the amount of money that you’ll need to have. That will require making larger contributions especially in the early going.

Some Investment Choices Handle Inflation Better than Others

It may also call for shifting some investment choices. You might, for example, put a heavier emphasis on sectors such as emerging markets and technology that tend to outperform the general market over the long-term.

You may also want to add holdings in sectors that benefit from inflation, such as energy and precious metals. These positions may not be very effective in times low-inflation, but they could be the high performers when inflation gets ugly.

When All Else Fails

Another strategy is to look beyond your retirement portfolio. That may mean planning to retain income earning skills such as a job or your own business. This isn’t to say that you’ll never be able to retire, but rather that you won’t be relying entirely on your retirement portfolio in the event that the inflation bite is particularly severe.

Part of the problem with inflation is that it’s impossible to know what it will be in the future. We can base estimates on past performance, but the future could look very different. No matter what, some allowance for inflation has to be built into your retirement portfolio plan.

We also have to remember that retirement planning is an attempt to prepare ourselves financially for a time that has not yet come, and that‘s never better than a guess. There are all kinds of variables, some of which we can never imagine or plan for even if we could.

We need to make our best effort to plan for retirement, but trust in our Heavenly Father who provides for us throughout our lives. Even if we don’t quite get it right, he’ll be there for us.

Some trust in chariots and some in horses, but we trust in the name of the Lord our God. – Psalm 20:7 (NIV)

Are you financially preparing for retirement? How will you account for inflation? Leave a comment and tell us your story!

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  1. Cedric

    Great article Kevin. I am trying to prepare my family for retirement. We are involved in some of the alternative investment options, such as real estate rental income, in addition to equities. We have one rental property and are looking to acquire additional property. I like stocks for beating inflation. However I don’t like that we would have to sell the stock asset in retirement in order to fund our living expenses. My understanding is that most stocks don’t provide enough dividends to cover withdrawals. I heard before that bond do poorly in periods of high inflation.
    I also like your idea of owning businesses. What are your thoughts on the types of businesses to acquire? Something that the individual is familiar with? Do you suggest franchises for those not familiar with how to run a business?
    While I seek first His righteousness (Matt 6:33) I also want to be a good steward of His resources.

    • Kevin M

      Hi Cedric, at the risk of sounding simplistic, find a business or trade that you actually like doing and have an aptitude for. Since you may have to do it for the rest of your life, it should be something that doesn’t feel entirely like work.

      What we often forget is that a full retirement is a relatively new phenomenon for the middle class. It’s only been around since World War II, so we may have to return to the methods people used way back when. That will most likely include some form of work, if only in a reduced capacity.

  2. Leo Cesna

    Excellent article Kevin,

    Coming up with “your” number, especially if you are young, is a daunting task. To compensate, I advise my younger clients to set milestones. For example for those in their 20’s I suggest a target of accumulating 1 years annual salary by the time they reach 30. Then 2.5 times their annual salary by the time they reach 40. After age 40, we have enough pieces of the puzzle to begin fine tuning their target number.

    The beauty of this approach is that the target stays attainable while still growing with inflation and career expansion. Every pay raise or promotion should prompt them to increase their target and contributions (savings as well as tithes).

    As you mentioned, diversification is vitally important as the first measure in protecting your savings.

    Ecclesiastes 11:2
    Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.

    But it is equally important to avoid investments that are not prudent in the current environment. For instance, the “Dot-Com” bubble attracted many to equities at the worst possible time in history, yet countless continued to dump their savings into an extremely overvalued market. Our recent housing boom followed by the financial crises was no different. Even now, some are concentrating their investments in areas that pose considerable risk.

    Proverbs 22:3
    The prudent sees the evil and hides himself, but the naive go on, and are punished for it.

    Proverbs 24:3-4
    By wisdom a house is built, and by understanding it is established; and by knowledge the rooms are filled with all precious and pleasant riches.

    Many professionals had warned that these bubbles would eventually pop but many ignored the warnings.

    Proverbs 15:22
    Without consultation, plans are frustrated, but with many counselors they succeed.

    • Kevin M

      Hi Leo, as to the bubbles and people loading up on speculations, that’s probably part greed, but mostly chasing yield. This is a problem of artificially low interest rates. There’s no where to go to get safe returns, so people load up on speculations. Some times they do it to make up for lost time. There’s no easy answer to this dilemma, it’s a real balancing act.

    • Leo Cesna

      True, but it’s not always greed that sends a persons retirement savings off the cliff. It can be lack of counsel as well. Many poor souls lost significantly in 2001 & 2008 while following what they believed to be prudent diversification of their retirement accounts. While others escaped early with only minor bruises, if any.

      Investing is not a static activity. As economic conditions change, ones investments should change as well. Economic cycles revolve just like seasons but on a wider scale. As the cycles begin to change, there are always signs that change is in the air.

      I’ve studied these cycles for more than 2 decades and use this knowledge to help others.

      For example, bonds have been the place to be for over a dozen years. And many folks are now invested in bonds and doing well. Yet, experts have been warning for several years that this bubble will burst at some point in time. When it happens, will the average IRA, 401k, or TSP investor know when to jump ship? Sadly, the answer is no. By the time they realize their retirement account has been crushed yet again, it will be too late.

    • Kevin M

      Investing is at best an educated guess. I’ve always been concerned that steadily rising markets make for complacent investors, but that’s never known until a slide hits. It makes a strong case for keeping some money in safe assets, even though they pay less than 1% interest, and having a plan B to investments at retirement (a job, a business, passive income sources, etc.)

  3. China Newz

    Great article Kevin. Some investment vehicles come with inflation protection. A lot of people don’t consider inflation when they retire. Treasury Inflation Protection Securities also know as TIP mutual funds will invest in treasury bonds. The bond is adjusted on a semi-annual basis with the rate of the Consumer Price Index (a measure of inflation). This could be a way to hedge against inflation in the long run while preserving your portfolio.

    • Kevin M

      TIPS can be an excellent retirement choice. At least as far as inflation goes,

  4. Leo Cesna

    Technical and Fundamental Analysis of the economy and the markets is far more than an educated guess. If that were true there would be a much higher turnover on Wall Street. We have been in a secular Bear Market since 2001 and will continue to be in one for at least a couple of more years. And everyone on Wall Street knows it. The information and knowledge is there. You just need to know where to look.

    Alan Greenspan, several congressman, and others warned of the housing market bubble several years before it occurred. Many warned of the impending “DOT COM crash” but the small investor wasn’t told what to do to protect their IRA or 401k. Even the President knows, but do you expect him to announce on national television that everyone saving for retirement should exit the stock market or bond market or housing market? Certainly not.

    In 2008, Jim Cramer warned his audience on national television to remove from the stock market any money they might need over the next 5 years. The man was almost lynched by his peers. Good investment advisors move their clients funds to safety as they see the landscape changing through their own personal analysis of the markets. They don’t want anyone creating a stampede. The best analysts see it developing soonest the consumer is told to “Buy & Hold”.

    Many years ago I was a staunch Buy & Hold advocate like yourself. Until one day the obvious became clear. If the market goes up when there are more buyers then sellers and goes down when there are more sellers than buyers, and the consumer is steadfastly pumping money into their 401k’s and IRA’s as buyers how can the market suffer a severe crash unless the sellers know something I don’t?

    Buy and Hold is not a strategy. It’s the only alternative you have unless you seek the knowledge yourself or find reliable council.

    I appreciate the opportunity to share my experience on your site. Thanks.

    • Kevin M

      Hi Leo, I’m not a buy and hold guy either. I think there’s a time to be in stocks, and a time to be out. But that’s a different discussion, and I’m not an investment guru!