Retirement Savings React to Inflation: Be Careful!

w1Financial adviser Ric Edelman of Edelman Financial Services has a warning to retirees: don’t just think about the safety of your investment portfolio. The reality is that most people are living longer than ever before, so they have more time to spend in retirement. (He points out that retirement is a relatively new phenomenon anyway: in the past, people simply worked and then they died. But with more technology, people now live longer, and retirement has become a reality for many people.

Living longer

Wait—that sounds like good news! More time to enjoy traveling, spending time with the grandchildren, learning a new hobby, taking it easy. What could be troubling about living longer, and spending a higher percentage of your lifetime in retirement?

The problem is that if you’re looking at 20 or 30 years of retirement, you need to treat your investment portfolio differently from if you expect five to 10 years of retirement. And that means paying attention to inflation.

w2Edelman notes that a study by the Ibbotson Associates indicates that since 1926 inflation has been averaging 3.2% annually. That’s a significant bite out of your savings and could drastically affect your retirement lifestyle. As Edelman points out, retirees don’t want to have their lifespan exceed the money they have to support it.

Stop that CD!

A lot of people make one mistake when they’re getting ready to retire: they put all of their money into CDs. This, Edelman counsels, is not the way to go. Of all the investments available to you, CDs are among the most volatile (and that taking into consideration the extreme volatility of the stock market over the past decade!). People have been trained to think that CDs are a good thing and that they’ll carry you through.

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Edelman offers an example of how bad a CD could be in terms of investment. Assume that in 1981 you put $10,000 into a one-year CD. Nice investment! The interest rate was around 15%, so by the end of the year you’d have amassed a tidy sum of $1,500. By anyone’s reckoning, that was a good deal. But here’s the thing: that interest rate only lasted for one year. Five years later in 1986, the interest rate was 7%. Going down, but you remembered the initial one-year bonanza and so you stuck with it. Well, by 2009, that CD was paying out only 1.7%. Not exactly working hard for you!

Now let’s say that you were a retiree living on that income. The difference between 15% and 1.7% is, you’ll agree, significant. Add in the factor that we started talking about at the beginning: inflation. So while your income was going down fast, the cost of living was going up. Groceries, transportation, travel, living expenses, all of that was going up. In 2009 you would have required $3900 in order to purchase what you only needed $1500 for in 1981. So you’re losing on both ends.

Systematic withdrawal planw4

So what’s the solution? It’s what Edelman calls a “systematic withdrawal plan.” In this scenario, you start, not by dumping all your money into a CD, but by building a diversified portfolio. Don’t put all of your money in any one place; there are a lot of investment opportunities available to you, and a good balance is what will keep your portfolio healthy. Your own financial planner and advisor can best help you diversify your portfolio, or Edelman points to his own guide to portfolio selection on his website.

If you’ve been sensible, this wouldn’t be news: you’d have had a diversified portfolio throughout your life so that when you retire there will be no need to panic—and no need to redo what’s already a healthy situation. But the reality is that most of us don’t have that kind of financial savvy, and it’s not too late to begin now. Then, says Edelman, the systematic withdrawal of 5% per year or less. This, not CDs, is what will keep your investments stable and your retirement smooth sailing despite inflation.