How does inflation affect your retirement accounts?

Inflation is a persistent rise in the prices of goods and services in an economy over a period of time. It is a natural occurrence that affects everyone in the economy. Retirement accounts, including 401(k)s, IRAs, and other retirement savings vehicles, are not immune to the effects of inflation. In this article, we will explore how inflation affects retirement accounts and how to mitigate its impact.

First, it is essential to understand how inflation affects retirement accounts. The value of retirement savings is eroded by inflation over time. Suppose you have $100,000 in your retirement account today, and the inflation rate is 3% per year. In that case, the purchasing power of that $100,000 will decrease by $3,000 the following year, meaning you will only be able to buy $97,000 worth of goods and services. The impact of inflation compounds over time, meaning that over several years, the real value of your retirement savings can be significantly eroded.

This impact of inflation on retirement savings is particularly relevant for retirees or those nearing retirement. These individuals typically have less time to recover from any losses resulting from inflation. Moreover, retirees rely on their retirement savings to provide a steady income to support their living expenses. If the value of their savings is eroded by inflation, they may have to make difficult decisions to maintain their standard of living, such as reducing expenses, taking on more risk in their investments, or working longer.

To mitigate the impact of inflation on retirement savings, it is essential to invest in assets that can provide a hedge against inflation. There are several investment vehicles that can provide this protection. One of the most common is Treasury Inflation-Protected Securities (TIPS). These are bonds issued by the U.S. government that adjust their principal value based on changes in the Consumer Price Index (CPI). As inflation rises, the principal value of TIPS increases, providing a hedge against inflation. When the bonds mature, investors receive the inflation-adjusted principal value, providing a guaranteed real return.

Another investment vehicle that can provide a hedge against inflation is real estate. Real estate has historically been a good inflation hedge because its value tends to increase with inflation. When inflation rises, the price of goods and services, including housing, tends to rise as well. Real estate investments can provide income through rental payments or capital appreciation as property values rise over time.

Investing in stocks can also provide a hedge against inflation. Stocks represent ownership in companies, which can increase their prices as they raise the prices of their products and services to compensate for inflation. Moreover, companies that can generate profits in inflationary environments tend to be more valuable than those that cannot. Inflation also tends to drive up interest rates, which can benefit financial companies that make money by lending money at higher rates.

However, it is important to note that investing in stocks carries more risk than investing in bonds or real estate. Stock prices can be volatile and can fluctuate significantly over short periods. Moreover, not all stocks are good inflation hedges. Some companies may be negatively affected by inflation, such as those that rely heavily on borrowing or have fixed costs that cannot be adjusted.

Another way to mitigate the impact of inflation on retirement savings is to maintain a diversified portfolio. A well-diversified portfolio includes a mix of stocks, bonds, and other assets that can provide a hedge against inflation. Diversification can help reduce risk and volatility in a portfolio and provide a more stable return over the long term.

In addition to investing in inflation-hedging assets and maintaining a diversified portfolio, it is essential to monitor the impact of inflation on retirement savings over time. It is important to periodically review your retirement savings and adjust your investment strategy as needed to ensure that it is aligned with your goals and risk tolerance.

Please feel free to reach out for help with any of your investment, insurance, or financial planning needs.  Chase Thomas cthomas@alphawealthfunds.com