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How can a retiree protect retirement savings against inflation?
Q: My biggest financial concern is inflation. I think I have enough saved for retirement, but that all depends on prices not rising faster than the value of my investments. How should I invest if I am concerned about retirement?
A: Inflation has been generally tame over the past couple decades, and particularly quiet over the past year, at just 0.2 percent. Still, it is not a good idea to get complacent about inflation remaining mild. A reversal in the direction of oil prices or perhaps a rise of protectionist sentiment in the course of the next presidential election could easily fire inflation back up again.
Inflation should be a consideration in any long-term investment approach, and it is a particular concern in retirement because you no longer have wages that can help your income adapt to the inflation environment.
Savings vs. CDs accounts for retirement accounts
As benign as the inflation threat has been in recent years, this is still a tricky investment environment for defending against inflation. A big reason is because interest rates are so low.
Traditionally, keeping money in short-term liquid vehicles like savings accounts has allowed people to keep pace with inflation reasonably well. The reason is that with interest rates on short-term vehicles able to adjust at any time, if inflation rises, they tend to rise soon afterward.
Unfortunately, Federal Reserve policy has resulted in unusually low short-term rates, so savings accounts have fallen behind inflation. Even though inflation over the past 12 months has been just 0.2 percent, the average savings account rate has been even lower, at 0.06 percent.
Since retirees need to keep some investments in stable and relatively liquid investments, one alternative would be to shop for a long-term CD with a good interest rate and a relatively mild penalty for early withdrawal. The best CD rates are up around 2 percent, which would put you ahead of the recent inflation rate, and as long as the penalty was not too severe, you could cash out of the CD early if rising inflation pushed interest rates higher.
Even once you retire, you should also keep some of your portfolio in stocks as a defense against inflation. Companies may adjust their business strategies to changing inflation trends, so while inflation can be damaging to stocks in the short-term, over the long-term, they are typically able to adapt to it. In particular, if there is an area of inflation that concerns you as far as your retirement expenses are concerned - health care inflation, for example - you could somewhat counteract it by investing in stocks in that sector.
The bottom line is that inflation, investment returns and life span are the big three uncertainties when it comes to retirement planning. Since there is no perfect investment approach to hedging against those uncertainties, the best response is to build in as big a cushion as possible in your retirement assumptions. You can do this by saving more before retirement, and spending less than you think you could afford after retirement.
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