As the holidays arrive, there are many constants in life to be thankful for: family, friends, and experiences, just to name a few. As many of us gather around the dinner table, discussions of internet hackers, early picks to win the Super Bowl, and stories of the past are bound to be debated. Perhaps the one thing that all of us deal with on a never ending basis—yet will never talk about—is inflation.
Inflation is the general increase in prices over time and has the effect of eroding the value of your purchasing power. A brief example of this would be if the inflation rate is 3%, then a $1 banana will cost $1.03 in a year. Although this may not seem like a big deal from one year to the next, over the course of several years, inflation has a huge impact on your financial well-being.
If you were to ask the average retiree who depends on an investment portfolio what his biggest concerns are, he would likely say that losing his principal—a legitimate concern—is at the top of the list. Unfortunately, this often leads to retirees becoming conservative in their investments the older they get. Many of them are making the critical mistake of substituting their investments into fixed income securities the older they get because the “experts” tell them that it is “safe” to do so. Nothing could be further from reality. The best way to protect yourself from inflation is to invest in equities. Over the past 85 years, equities have outpaced inflation, on average, by a fairly wide margin (8.28%), while bonds, represented by the 10 year T-Bill have barely outperformed inflation (2%). As retirees live longer the importance of staying invested in equities cannot be understated.
For example, suppose you retire today and have $40,000 of expenses. Assuming that you experience the same rates of inflation that occurred from 1993-2013, your expenses would grow to $64,480 (a 61.2% increase). For retirees who are living on a fixed income—a pension, CD ladder, or bonds—this is a killer. This means that you would have to make up the $24,480 difference by other means in order to maintain the same standard of living or cut back your lifestyle. Ultimately, inflation is a far more serious threat to your long term financial stability than the ups and downs of the stock market.
About Christopher M. Jones, CFP®
Christopher M. Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm based in Hermosa Beach, CA. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management. Chris is a CERTIFIED FINANCIAL PLANNERTM practitioner.