Inflation has been a main topic of conversation in economic, consumer, and political circles for some time now, and for good reason. At its core, inflation can be detrimental to our money by eroding its purchasing power, particularly for retirees and others living on fixed incomes with little wiggle room for unpleasant surprises.
In my past articles on interest rates, here and here, I discussed how rising rates to combat inflation have affected bonds and investment portfolios. In this article, I discuss how inflation affects retirement planning and what you need to know to avoid nasty surprises in the future due to inflation’s effects on your spending and the longevity of your retirement assets and income.
What Inflation Numbers Should I Be Monitoring?
The most widely used and cited measure of inflation is the Consumer Price Index (CPI), compiled by the U.S. Bureau of Labor Statistics (BLS). The CPI measures monthly price changes experienced by the vast majority of the U.S. population, but it is an average and doesn’t reflect actual consumer experiences. The U.S. government uses a version of CPI (for Urban Wage Earners and Clerical Workers) to adjust Social Security benefits for inflation each year.
The Personal Consumption Expenditures (PCE) index is another measure of inflation. This figure uses BLS price data; compiled by the Bureau of Economic Analysis, it’s the primary measure of inflation used by the Federal Reserve to guide the Fed’s interest rate adjustments. The main difference between the PCE and CPI is that the PCE measures price changes for all consumption, whereas the CPI only measures direct consumer out-of-pocket spending. In addition, economic sectors have different weighting in each index; in the CPI, housing costs are about 42% of the index versus just 22% in the PCE. Medical costs, on the other hand, comprise 22% of the PCE, but only 8% of the CPI. Of the two, PCE is often regarded as the more accurate measure of inflation.
In addition, economists and analysts often watch Core Inflation to obtain an even better measure of inflation pressures. Core inflation can include either the CPI or PCE but with food and energy prices excluded, since these tend to be more volatile in price over the short term.
Since CPI is the most widely used and watched index, and because it’s the figure used to adjust Social Security income benefits, it’s probably the best to monitor inflation by the average person.
Is Inflation Still a Problem or Is It Coming Down?
Inflation is a main concern of consumers today, and many believe it is still a problem. In reality, inflation is coming down and the Fed seems to have (so far) achieved its objective of bringing down inflation through monetary tightening without significantly affecting economic growth.
Part of the misconception among consumers is rooted in remembering past price levels prior to inflation taking hold after the COVID pandemic. There’s also the misunderstanding between “disinflation” (a decrease in the rate of rising inflation) and “deflation” (an actual decrease in prices and inflation reversing). Disinflation is actually a good thing and what the Fed is trying to achieve (slowing the rate of inflation). Deflation, however, indicates prices falling due to lower spending—something that isn’t happening in the U.S. economy at the moment and which the Fed wants to avoid, since lower spending could lead to a recession.
What Is the Impact of Inflation on My Retirement Spending?
Inflation and price increases are certainly important variables to incorporate into a retirement income analysis. Since future price increases are difficult to predict, an assumption of average year-over-year spending increases to maintain a retiree’s lifestyle should be included in the analysis. Many wealth managers use a 3% annual increase in spending as a proxy for what a retiree might experience in future years over time.
For most retirees, this ends up working well. For those that are spending at their maximum level each year with little to no margin of safety, periods of excess inflation can cause problems in the longevity of retirement assets. By withdrawing more retirement capital than projected in the plan over time to continually pay for a higher-cost lifestyle, a retiree may end up reducing retirement principal that will no longer be left to grow for the future.
This is where the annual or periodic review of the retirement plan can be useful and informative to both the wealth manager and the client, such as we provide at our firm through our Wealthwhile℠ approach, to help preserve the integrity of the long-term plan.
For our clients, Deerfield Financial Advisors utilizes investment and planning strategies designed to support both short- and long-term financial goals, guiding you on your journey toward financial independence.
About Marcus
Marcus Miller is Wealth Manager and Shareholder at Deerfield Financial Advisors, a fee-only financial services and wealth management firm with offices in Indianapolis and Chicago. His role includes strategic planning, income tax optimization, insurance and estate planning, and investment management for a diverse group of clients. Implementing Deerfield’s unique financial planning approach called WealthwhileSM, Marcus helps clients live their best lives and focus on their most worthwhile passions. He is passionate about helping them pursue, experience, and maintain true financial independence for their families, without the sales pitch. He truly enjoys helping people and developing deep, meaningful relationships with clients.
Prior to joining Deerfield in 2012, Marcus gained valuable experience at a Big Four accounting firm, a nationally recognized brokerage house, and a distinguished independent advisory firm. He holds a Bachelor of Science and Master of Science in Accounting from Ball State University, the Certified Public Accountant and CERTIFIED FINANCIAL PLANNER™ designations and is a NAPFA Registered Financial Advisor. Marcus serves on the Board of Happy Hollow Children’s Camp and on the Planned Giving Committee at the Indianapolis Zoo. He is a member of the Professional Advisor Leadership Council at the Central Indiana Community Foundation (CICF) and is involved at his daughters’ school.
Marcus resides in Carmel, IN, with his wife, Andrea, and their two daughters. They love spending time outdoors hiking, bicycling, camping, and traveling to national parks. (They have a goal to visit all 63 national parks; Yosemite is the current favorite.) An avid reader, especially of non-fiction, history, and finance books, Marcus also trains in Brazilian Jiu-Jitsu, likening it to a physical chess match that involves problem-solving and mental strengthening with physical consequences. To learn more about Marcus, connect with him on LinkedIn.
