At a time when we’re experiencing renewed volatility in the stock market, it’s easy to be influenced by fear. When you turn on the news, the media tends to focus on just one risk — stock market risk. They rarely mention a risk that may be even greater — inflation risk.
The annual rate of inflation averages out historically to 4 – 4 ½% per year. It doesn’t sound like much. However, over the course of 25 to 30 years of retirement, it can become a big deal. When the market is in the midst of a correction, it’s tempting to move retirement assets to the low, but guaranteed, interest offered by banks, or the somewhat higher income presented by fixed annuities.
Returns from the stock market are not guaranteed. That’s why your investment prospectus tells you, “Past performance is no guarantee of future results.” However, it is this risk that forces the stock market to give the potential to receive much higher returns than guaranteed, fixed investments. When there is a growing gap between rich and poor, and the middle class is paying for big tax breaks to corporations, the stock market may be one of the few ways for average people to participate in the growth of the economy.
In order to not lose ground financially, we have to find ways for our assets to grow at least as fast as inflation. To give you an idea of the impact of inflation over a long period of time (like your retirement), check out this free, online calculator at:
Input your current age, the income that you are receiving, and the year in which you think you might pass away. Don’t be too conservative about your life expectancy. A study by the Society of Actuaries Committee on Post-Retirement Needs and Risks stated that, “For a couple 65 years old, there’s a 25% chance that the surviving spouse lives to 98!”¹ The calculator will tell you what your income will need to be at some point in the future in order to maintain your purchasing power, and maintain your current lifestyle.
For example, suppose that you are age 65 today, and you are receiving an income of $100,000 per year from an annuity, and that income stays the same over your lifetime. How much of your future lifestyle will that annuity sustain by the time you’re 90? The calculator shows that when you assume an inflation rate of 3% per year, you would need $209,378 at age 90 to enjoy the same lifestyle you enjoy today. In other words, the annuity would provide less than half of what you need at age 90.
Remember that I said that average inflation is closer to 4 to 4 ½% per year. If we use a 4% inflation rate, the future income needed to match today’s $100,000 rises to $266,584.
I’m not saying that all annuities are bad. There are good annuities and bad annuities (we’ll get into that at another time). A good annuity is appropriate in the right circumstances as part of an overall retirement strategy, especially for people who aren’t so fortunate to retire with a pension. However, when you see the results of your own calculation, you can understand why it makes sense for many retirees to assume a moderate amount of risk in a broad, globally-diversified portfolio.
Investments that grow over time may make it possible for you to afford a comfortable future retirement. The safety of bank CDs and guaranteed fixed income from annuities can have a place in your retirement strategy, but if they are the only assets you have, you may be swapping a guarantee not to lose money for a guarantee that you will run out of money in retirement.
¹ USA Today, 10/5/2016