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Rising inflation – especially the kind of record high inflation seen recently – will always be in the headlines.
While many people worry about how they will be able to afford increasingly expensive products, retirees tend to worry more about the loss of value of their savings. When “safer” investment options, such as corporate and government bonds, offer returns significantly below the rate of inflation, this is an understandable concern.
Let’s take a closer look at the impact high inflation can have on your portfolio, why keeping cash in cash can be a mistake, and how to help your retirement portfolio become inflation-proof.
How Inflation Can Affect Your Retirement Savings
Many retirees wonder if they will do well in retirement. Will they have enough to spend and will their savings last? Inflation can certainly make your investments less valuable unless your retirement income can keep up.
That’s why it’s important to know the details of all your sources of retirement income. Some of them, like the Canada Pension Plan and Old Age Security, are adjusted regularly for inflation.
However, other income may not be adjusted for inflation, such as certain company pensions and retirement savings (for example, investments in your Registered Retirement Savings Plan and savings accounts tax free). The ability of these investments to beat inflation will depend on their performance.
In a situation like the one we experienced in 2022, with high inflation and a slowdown in financial markets, some retirees could see part of their retirement savings lose value, at least in the short term.
If inflation causes a significant shortfall in retirement income, there are a number of options available. You could delay your retirement, work part-time in retirement, reduce your retirement expenses, or downsize your home and use the equity taken in to cover the shortfall. None of these are ideal, but there are ways to prevent them from happening.
Converting investments into cash is not the solution
A common reaction when financial markets begin to lose value is to sell stocks, bonds and mutual funds and convert them into cash accounts. From a pure investment standpoint, this can be a reckless move, as you’ll lock in your losses and could miss out when the market rebounds. Your wallet could take a long time to recover.
From an inflation protection perspective, this is even more of a losing strategy. Most savings accounts offer 2-3% interest, which would be considerably lower than inflation in 2022 (it peaked at 8.1% in June). At 8% inflation, cash savings that increase by 3% in interest will effectively lose their value by 5% per year.
Fortunately, there are several strategies that can help protect your retirement savings from the ups and downs of inflation.
How a Long-Term Financial Plan Can Beat Inflation
A solid long-term financial plan will take into account a number of potential variables, such as longevity (how long you will live), market lows, and inflation.
It is very important to test the financial plans for several possible scenarios, for example what would happen if the investments were to perform worse than expected or if inflation were to soar? You should also review your plan every year – a life plan should adjust and adapt to changing markets and your personal circumstances.
The earlier you start saving, the more time you have for your investments to grow and reap the benefits of compound returns. The more you save, the bigger your safety net against inflation.
How a well-diversified portfolio protects against inflation
It should be remembered that inflation in Canada has rarely exceeded 3% for most of the past 30 years. When planning for the long term, FP Canada recommends using an annual inflation rate of 2.1% for pension plans.
Portfolios that contain a good percentage of equities (stocks or mutual funds containing stocks) have historically always significantly outperformed inflation, over the long term. You would also need your portfolio to be well diversified – it should contain a good spread of industries and geographic locations.
Additionally, investing in businesses that can pass on rising costs to customers, such as grocery stores and other retail outlets, will also help protect your investments against inflation.
Other Strategies to Protect Retirement Savings from Inflation
Some investment assets may perform better than others in times of high inflation.
Commodities, such as oil, gas, wheat, etc., tend to have fairly constant demand, so price increases generally have little effect on their consumption levels.
Inflation-protected assets, such as real return bonds and Treasury inflation-protected securities (TIPS), are designed to provide cash flows that follow the cost of living. Both are available in mutual funds.
Real Estate Investment Trusts (REITs) offer an easy way to invest in real estate without owning it. Pooled money means your risk of unpaid rent should be lower. The value of Canadian real estate has, on average, increased significantly above the rate of inflation over the past 15 years.
Make sure your retirement portfolio is inflation proof
Your Certified Financial Planner can talk with you about your retirement needs and develop a solid financial plan that will help you understand the steps you need to take to get the income you need, when you need it.
These plans may be stress tested for inflation, as well as other variables, such as market volatility and longer life.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.