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How to plan for, mitigate inflation’s impact in retirement

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It is a tough time to be considering or in retirement. Retirement investors face high and rising inflation, historically low interest rates, and stock market volatility.

My husband and I debate when it will be the right time for him to retire. His financial concerns change over time, and right now his primary concern is inflation.

When the stock market goes down, it comes back up. The concern with inflation is that, when prices rise, they don’t come back down. He is keenly aware that, over time, inflation will eat away at purchasing power.

Inflation is typically defined as “a sustained increase in the price level for goods and services throughout an economy.” Inflation is neither all good nor all bad. While too much inflation is generally considered bad for an economy, too little inflation is also considered harmful.

Many economists advocate for a middle ground of low to moderate inflation, of around 2% per year. Inflation for 2021 was 7%, and we are currently hovering around 8%. This is a phenomenon the United States hasn’t seen since the early 1980s. It is yet to be determined if this is a short-term blip or more long lasting.

The primary concern for retirees is how inflation impacts their ability to live well during their retirement years.

Inflation affects how they allocate their money on important necessities such as health care. Other areas that can drive up retirees’ expenses are housing, travel and supporting adult children. Higher food, gasoline and utility costs mean less money for discretionary spending.

While seniors can’t directly affect the inflation rate, there are ways to minimize the shadow it casts over their retirement. Standard options include reducing spending, switching to cheaper substitutes, or looking harder for bargains. Many retirees are figuring out how to do meaningful things in a more affordable way.

Another smart move is reevaluating your investment portfolio. Dimensional Fund Advisors Research team recently evaluated the ability of common investing and spending strategies to support smoother retirement consumption.

According to Dimensional, “an income-focused approach to investing can help address risks to retirement income even under challenging circumstances.

The income-focused approach has two distinguishing ingredients. The first is a moderate exposure to equities in retirement to help mitigate market risk. The second is an allocation to bonds designed to protect against the risks of rising inflation and falling interest rates.”

Because stocks, over time, have a much higher return than bonds, maintaining a slightly higher allocation will help mitigate inflation risk. Using inflation-adjusted fixed-income products, like Treasury Inflation-Protected Securities, is another strategy.

Other common portfolio changes include adding exposure to real estate, or energy-sector stocks that are likely to increase in value as inflation rises.

Annuities, which are specifically designed to manage longevity risk, are another option. We also encourage our clients to delay starting Social Security until age 70. This increases the initial Social Security payment, and this higher payment amount is the baseline to which cost-of-living adjustments are applied, resulting in higher payments for life. This is especially important for spouses with significantly higher lifetime earnings.

Key takeaways from Dimensional’s research include:Retirees following conventional wisdom and investing in short-term, minimal fixed income are more vulnerable to inflation increases or interest-rate drops.

Pursuing an income-focused allocation can provide more-predictable retirement consumption by addressing

both risks.

Remember, however, that inflation is only one consideration among many that investors must contend with when building a portfolio for the future. The right mix of assets for any investor will depend upon that investor’s unique goals and needs. For those who are particularly sensitive to unexpected inflation, the protection offered by inflation-indexed securities still appears to be the most effective.