How Inflation Erodes Your Retirement Savings (and What to Do About It)

  • Many investors following traditional retirement investing advice may not be considering the full impact inflation may have on their portfolios.
  • Diversification is key to achieving a strong mix of capital preservation and portfolio growth.
  • There are different types of “all-weather” portfolio strategies available to investors; it’s a matter of finding an iteration that best matches your financial goals and risk tolerance.

It’s a common narrative in American financial culture: the older you get, the more conservative your investment holdings should be–something like a cookie-cutter solution. But can it be that simple? With the average inflation rate floating between 2% and 3%, it seems as if any retirement portfolio heavily weighted toward fixed-income might be neglecting the impact of inflation while turning a blind eye to other assets that may outperform it in terms of returns and risk mitigation.

Considering that Americans are just now beginning to wake up to the current inflationary surge–whether it’s a “transitory” phenomenon, or a major Fed policy misstep–it might be time to re-examine this common investment adage, for the difference it can make to your future retirement lifestyle is significant. It’s a matter of having enough to live out your golden years, versus running out of funds in the middle of your retirement.

A Comfortable Income Today Will Be Worth Much Less Tomorrow

Let’s suppose you live an upper middle class lifestyle with an annual income of $75,000. You plan on retiring this year figuring that all you need is that exact amount in fixed-income to maintain your comfortable lifestyle.

If you factor-in a steady 3% inflation rate, then in 20 years, you’ll need $135,438 to purchase what $75,000 can buy you today. That’s an 80.6% erosion to your future wealth. And consider the fact that the average American lifespan has been increasing due to advances in medical and healthcare technologies. If you go on to live for another 30 years, you’ll need $182,045–a cumulative inflation rate of 152.7%!

For decades, Americans have been living under a relatively modest rise in inflation. The pandemic has prompted the Federal Reserve and the government to become more aggressive with monetary policy and fiscal spending. Just how aggressive? Let’s take a look.

Around 23.6% of all dollars in existence were created in 2020 alone. This means there’s more money in the system soon to be chasing fewer goods–the classic definition of inflation. A transitory blip, or a slower and longer-term sludge in the system?

US M1 Money Supply 1975 – 2021

US Money Supply
Source: St. Louis Federal Reserve

What about the US national debt? It currently stands at $28.4 trillion. In case you haven’t quite realized it yet, the national debt is a potential claim on your future income and wealth, either through taxation or the devaluation of your purchasing power (again, inflation).

US National Debt July 4, 2021

US National Debt
Source: US Debt Clock

Your ‘Personal’ Inflation Rate Is Yet Another Separate Factor

Monetary inflation may affect the broader economy, but bear in mind that your personal inflation rate can exceed or fall below the current inflation rate depending on your age and your needs for certain goods and services that may increase due to age–especially healthcare services.

According to FactSet data, between 1989 and 2017, college tuition and hospital services increased by over 350%. Medical care and the cost of pharmaceutical drugs rose by around 175%. Doctor services rose  by nearly 150%.

Meanwhile, the overall Consumer Price Index rose by around 90%. What this tells us is that healthcare services and college tuition are among the goods and services experiencing the largest inflationary increases across nearly all sectors of the economy.

And healthcare will likely play a significant increasing factor in your personal inflation rate. The question is, how can you preserve your retirement capital while also pursuing the necessary growth to outpace inflation?

Average Annual Return of Assets Relative to Inflation 1971 – 2021

To get a clearer picture of what you might do moving forward to offset the effect of inflation, let’s take a look at some data, according to Statista. Starting in 1971 (the year that President Nixon took the US Dollar off the gold standard).

  • Inflation increased annually by an average of 3.86%
  • US stocks increased an average of 10.94%
  • Commodities returned an annual average of 10.69%
  • Gold returned an annual average of 10.61%
  • Real Estate returned an average of 9.8% (over a two-decade period according to Investopedia)
  • US Bonds returned an average of 6.02% annually

If you invested in bonds, you barely made double the average inflation rate. Stocks, commodities, and gold provided the highest returns. What’s not included here, yet something to consider, is income from rental properties (for those who decide to become landlords).

Sounds like an easy fix–just invest in almost anything and you’ll outpace the inflation rate–doesn’t it? Not so fast. What if you sink everything into one asset class, and that asset class ends up taking a dive early on in your retirement? Even worse, what if your personal inflation rate surges, say, due to an illness or hospitalization? Sounds like you’re in a lot of financial trouble. What then?

Diversification is Key to a Wiser Retirement Strategy

No level of economic smarts or calculation will ever amount to a crystal ball. So, don’t try to predict which asset classes might perform best at the expense of sacrificing diversification.

It’s always wise to seek an opinion from a financial advisor. But be wary of advisors who are limited to specific asset classes (such as equity and debt securities). If they’re paid based on allocations to those specific classes, they’ll hold a bias against other assets (e.g. precious metals and real estate) that can be tremendous assets in your portfolio.

There are many ways to combine various asset classes to come up with an effective and well-diversified portfolio. The possibilities are beyond the scope of this article. But bear in mind that there are many ways to do it, so stay open to many possibilities.

Is There Such a Thing as an All-Weather Portfolio?

What if you wanted to hedge against inflation and other kinds of economic slumps while catching most bullish opportunities in various markets? If this is what you’re thinking about, it sounds like you’re describing a type of “all-weather” portfolio.

As with the variety of diversification strategies, there are also several varieties of all-weather portfolio models. What we’re about to share with you is a relatively popular and easy portfolio model. It’s not the be all and end all of all-weather portfolio-dom, nor is it guaranteed to always remain effective (no portfolio, short of a Ponzi scheme, can ever guarantee consistently strong returns).

Have you ever heard of Harry Browne’s Permanent Portfolio? The allocation is quite simple:

  • 25% in stocks
  • 25% in bonds
  • 25% in physical gold
  • 25% in cash (money markets or CDs)

Already, you can see the possible different iterations based on the same concept: total stock market ETF + US Treasury Bond ETF + Gold-backed ETF (or even investing in a silver/gold split since the white metal is both a monetary and industrial metal) + Money Market ETF.

The idea behind this strategy is to keep the percentage allocations constant–meaning, you would have to rebalance your allocations at the end of each year to re-establish the even 25% split across all four asset classes.

So, what of the Permanent Portfolio and its performance? According to investment analyst Harry Browne, a Permanent Portfolio strategy would have returned an annual average of 8.65% from 1976 to 2016 for a total return of 2,600%, according to Investopedia. A standard 60/40 stock-to-bond allocation would have generated a 10.13% annual return for a total of 5.050%.

The site did a more recent study, a 15-year calculation of Permanent Portfolio performance implemented by two funds that followed the strategy–iShares and Vanguard. Overall, the results weren’t far off from the returns mentioned above–an average of 7.84% annual return from 2006 to 2020.

Pursuing Capital Preservation and Portfolio Growth

Some advisors believe that no instrument can provide you with “capital preservation”–or, protecting your wealth with minimal risk–and “portfolio growth” at the same time. Hence, you mix and match assets for a little of both.

You should be careful applying such a principle to viewing different asset classes, as each asset has different growth cycles. Bull and bear market cycles in the stock market differ considerably with those of gold, commodities, and real estate.

And while inflation may also exhibit cyclical tendencies…

US Inflation Rate from 1914 – 2021

Inflation Rate

It’s effect on the US dollar is not…

Buying Power

The Bottom Line

The effect of inflation on your purchasing power is that of a slow and steady decline. Recently, inflation seems to be accelerating, and nobody can be absolutely certain as to its duration or the depth of its debasement.

However, it’s impact on your retirement savings, if you’re not careful, can be severe, especially if your personal inflation rate soars above the monetary inflation rate. Hedging your portfolio is always a wise idea. For this reason, we recommend gold IRA rollovers.

And hedging in a manner that provides optimal preservation and growth is achievable, as long as you put in enough time, research, and careful deliberation into your investing plan.

Other Articles You Should Read

I’ve written a couple of other articles that I believe you will enjoy reading. Here’s a list of a few that are must-reads for you!

Goldco Precious Metals Review

How To Move 401k To Gold Without Penalty

Precious Metals Storage Facilities