Retirees and those close to retirement have seen their fair share of market corrections and crashes, and know that the stock market can quickly lose value under certain circumstances. But the reversal shows a long-term upward trend.
While many retirees are understandably worried about the stock market producing a bad year when they leave their jobs, that may not be the biggest hurdle their portfolio will face. Although the stock market can have dramatic price swings, the silent erosion of purchasing power by inflation is a threat that should not be ignored.
The real threat: inflation over time
Inflation can deplete retirement savings accounts without you even knowing it. A typical inflation rate of 2% to 3% may not sound like it would do much damage, but it can eat into your savings in the long run.
Health care inflation tends to be very high. And health care costs can increase significantly as you age.
Why the stock market is not a big deal
Although the stock market is subject to periods of extreme volatility, it tends to rise over time. Companies are recovering, consumers are spending with confidence and commodity prices are rising.
Meanwhile, bonds do not keep pace with inflation and cash is guaranteed to lose purchasing power over time. Retirees who flee to the “safety” of cash end up enduring decades of buying power erosion and missing out on the growth potential of stocks.
The stock market, of course, comes with risks. You shouldn’t be completely invested in one stock, and there are ways to diversify beyond the S&P 500 index fund. However, an all-cash approach can ensure that you lose long-term buying power.
How are portfolios resistant to inflation?
An inflation-resistant portfolio consists of multiple asset classes. It not only focuses on high-growth sectors like technology, but also offers several options to mitigate the impact of high inflation.
Treasury Inflation-Protected Securities (TIPS), I-bonds, dividend growth stocks, real estate, gold and commodities are some of the investments you can find in a well-balanced, diversified portfolio. Gold in particular can be an important inflation hedge with a long history. It has been the medium of exchange for thousands of years, and more recently, it has a history of outperforming the stock market during times of high inflation and global uncertainty. Most experts recommend allocating 5% to 10% of your overall portfolio to gold.
Social Security COLA limits
Your Social Security benefits are designed to provide some protection against inflation, but they are not an ironclad solution. The cost-of-living adjustment (COLA) figure is based on the consumer price index, which measures inflation and may not account for price increases for retirees who spend more on health care and housing. Prices for some categories are rising at faster rates than others, and that can make COLA benefits feel inadequate.
