Inflation And Your Retirement

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Inflation And Your Retirement

Now that we are in a cycle of reducing inflation and consequently reducing interest rates, it is worth reviewing how inflation affects your retirement and what you can do to protect yourself from inflation in the future.

By Warren Ingram. CFP®

Now that we are in a cycle of reducing inflation and consequently reducing interest rates, it is worth reviewing how inflation affects your retirement and what you can do to protect yourself from inflation in the future.

How does inflation affect your retirement?

When the cost of living increases rapidly, central bankers are forced to tame the inflation monster by increasing interest rates. The aim is to slow down economic growth by increasing borrowing costs and limiting the amount of excess cash flow available to companies and individuals. This is a rather blunt instrument but the most effective tool for central bankers. Now that global economies are entering a period of slowing inflation and falling interest rates, it is worth understanding how inflation impacts your retirement and what you can do about it.

Inflation is a fact of life for everyone; it is also one of the things we cannot control.

Your cost of living will always increase over your lifetime. You cannot control when this will happen or how quickly the costs will rise. Sometimes, inflation will moderate, and costs will increase slowly, and at other times, costs will rise by 8% to 10% per year. It is an option to delay big, lumpy expenses like vehicle replacements and overseas holidays until inflation has slowed down again. You could also try to reduce your regular expenses, but some costs are obligatory, e.g., medical aid and essential foods are a necessity.

What can you do about inflation:

Retirees need to invest differently to protect themselves against inflation. You have to realise that inflation is the silent killer of retirement money. Most people would instinctively avoid stock markets once they have retired because they don’t want to risk the volatility of markets. This is a factor, but stock markets are your biggest inflation protection as shares grow much faster than the inflation rate over time. Avoiding the stock market might be the riskiest thing you could do as a retiree. I feel that all retirees should have a minimum of 35% to 40% invested in shares, with the ideal allocation being 65% to 75%. The remainder of your assets can be invested in government bonds, property companies and cash. While a 75% allocation to shares might seem high, it is worth remembering that a 65-year-old retiree might live for another 30 to 40 years.

Diversify your sources of growth

You should not invest all your money in the stock market. Allocating some money to government bonds, property companies, and cash is a good strategy. This also applies to international investments. Allocating money across all of these asset types ensures more consistent growth. Most people should have at least 25% of their investments allocated overseas. The offshore allocation should increase as your wealth increases. For example, suppose you have enough money to cover your expenses over your lifetime and provide your children an inheritance. In that case, you should increase your overseas investments to 50% of your assets. It should rise to 75% for families with multigenerational wealth as you are investing for at least two generations into the future, which is a very long time!

Avoid the big risks

Many newly retired people with limited funds start businesses with their retirement money. Many of them open coffee shops, start franchises or lend their children money to start businesses. It is rare that any of these strategies actually pay off, which can cause a permanent loss of capital. This worsens an already compromised retirement. If you are tempted to lend your children money or to start your own business, it is vital that you do so with a very limited amount of money so that you don’t harm your financial position if things don’t work out as planned.

Another dangerous strategy is to invest in high-growth investments recommended by your friends at the golf club or some other social setting. In most instances, friends don’t provide context to the growth of their investments, including what risks were taken, what the returns were in previous years, etc. You also need to be wary of scams; very often, people are hooked by their friends unwittingly recommending scams as high-quality investments. We tend to place great value in our friends’ recommendations, so we don’t do the proper due diligence as we would with any other investments. This is why scams snowball. Promises of very high returns from investments that “cannot lose money” should be a warning sign. You could be allocating money to a scam. This is particularly true when it is only offered to select people and is unregistered and unlisted – this is a typical marketing ploy of scammers.

In summary, you should ensure that you have an investment portfolio that offers sustainable growth that exceeds inflation without taking excessive risks. This can be achieved through proper diversification and maintaining a long-term focus.

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