Over a few decades, even a little bit of inflation can have a big effect. If your retirement was to last 30 years, Figure 3 projects what today’s $50 bag of groceries today could cost in 30 years based on various inflation rates. Put another way, in 30 years at 3% inflation, you’d need $2.43 to buy what $1 could buy today.

Second, the Psychological Effects of Inflation

Lately, it’s been hard to avoid hearing about inflation. It’s been all over the news. According to a November 2021 Gallup poll, 45% of US adults said inflation is causing them financial hardship.¹² So how can inflation affect our mindset as we approach, or are in, retirement? Many retirees rely on a fixed income, e.g., interest from bonds or CDs. As a result, they may be more vulnerable to inflation because their income may not increase enough to keep up with rising prices.

When products and services become less affordable, people can try to adjust by making fewer purchases or buying less expensive alternatives. They might also cut back on spending by giving up pastimes they enjoy. Unfortunately, this type of sacrifice comes with a cost of its own. It can make people feel anxious, insecure, and like they’re missing out on the good things in life.

If, to keep up with rising prices, a retiree needs to withdraw more from savings, their assets could begin to dwindle faster than expected. Doing so could raise fears about running out of money at some point in their retirement.

In retirement, many people think it’s best to invest less in stocks and more in investments perceived as “safe,” such as bonds, CDs, etc. Why? We may fear losses from stock-market volatility and the effect it could have on our income. But historically, over the long-term, fixed-income investments have provided lower returns than bonds and cash investments (see Figure 4).

As Figure 4 shows, over the last 30 years, equities have significantly outpaced inflation. The outpacing occurred despite six bear markets (market drops of more than 20%). The average drop of the six bear markets was 37% and the biggest drop was 52%.¹³

CDs can be especially attractive to retirees because they tend to be less volatile than equities or bonds. But when cash returns are adjusted for inflation, they can be less reassuring. The inflation-adjusted return of CDs has been negative for the past five years (see Figure 5).

A financial professional can help you determine a mix of equities, bonds, and cash tailored to meet your income needs for a 30-year retirement. They may also consider commodities, real estate investments, and other types of investments to help guard against inflation.

Delaying taking Social Security benefits could also help guard against inflation in retirement because every year you delay taking it, your benefit increases 8% each year up to age 70.¹⁴ Visit the Social Security website to see what your benefit could be at various ages, e.g., 62, 67, or 70.

“But Stocks Are Too Risky in Retirement”

Equities tend to be more volatile than fixed income. In the past 30 years, we experienced significant bear markets, including Black Monday in 1987, the dot-com bubble, the Great Recession, and a global pandemic. Each of these events triggered market drops of 30%. Yet, despite these drops, the S&P 500 Index rose from 326 points on January 2, 1991, to 4,766 on December 31, 2021. During that time, your income would have to rise about two and a half times to keep up with 3% inflation. The S&P 500 Index rose more than 10 times.

To Summarize

First, the average inflation rate for the past 10 years has been 2.1%. But in January 2022, inflation jumped to 7.5%. Second, when inflation is rising, we may feel the effect financially and psychologically. Third, the growth of equities has historically outpaced inflation.

We Haven’t Heard Much About Inflation for Decades

When inflation’s low, its effects are somewhat forgotten about, similar to George Walton’s nickel that was put away in a drawer. But over time, even low inflation can have a big impact on our cost of living. Retirees should work with a financial professional to choose investments that can keep pace with inflation.