Rising inflation seems to be the hot topic garnering more attention in recent months. If you turn on the news or go to any financial media source, you will see inflation headlines splashed across the front page. The media talks like it’s a brand-new phenomenon, but it is far from new.
Why does inflation exist? We use a fiat currency in our modern economy. This means our money is issued by the government and not backed by any type of physical asset or commodity, such as gold. Inflation occurs when there are more dollars chasing the same amount of goods and services. Those goods must become nominally more expensive in order to trade at the same value. We are now seeing higher inflation due to massive stimulus, or money, being injected into the economy by the Federal Reserve’s monetary policy. In our current environment, there is also a shortage of product available created by supply chain disruptions for goods in high demand. We now have more dollars in circulation due to monetary policy, chasing fewer goods and services due to supply chain issues.
People experience inflation and the cost of living differently. A young family with multiple kids will sharply notice the rise in childcare costs. A couple in their mid-70s may feel prescription drugs and other areas of healthcare are on the rise. Consumer price index, or CPI, is one measure of inflation. CPI uses the cost of a basket of goods to calculate the cost of living. The actual basket of goods needed for living can look very different depending on a person’s stage of life.
Why does this matter, especially in retirement? We have found that inflation for those in the midst of their careers can feel significantly different than those in retirement. When I ask clients near retirement if they recall their annual salary when they first joined the workforce, it often results in a chuckle. Personal progress can mask the impact of inflation during a career. People earn promotions, move up the food chain, receive cost of living raises, and ultimately have an earnings rate that outpaces inflation.
Retirement is when a person can be caught in an inflation trap. Fixed income refers to a nominal payment that does not change over time. Fixed annuities and pensions, without cost-of-living adjustments, will lose value each year inflation is positive. A retiree also needs to be confident that any pay raises taken through asset distributions are sustainable and do not jeopardize longevity.
As you near retirement, consider how your costs may change in the next several decades. Will your income and pay increases cover your costs and future goals? A robust plan and a diverse income approach can help lower the risk of losing income value during retirement. The rising inflation headlines may change, but that doesn’t mean the conversation should stop. We want our clients to be prepared for inflation regardless of the headlines.