How Inflation Can Impact Your Retirement Plan

by | Mar 17, 2022 | Financial Planning

With inflation at a 40-year high, many are concerned with how higher prices will impact their budget and their savings. It’s true that inflation will impact almost every aspect of your financial life, but what does that mean for your portfolio?

To properly take advantage of this inflationary environment, you must first understand how inflation impacts your budget and various types of investments. Once you are armed with the proper knowledge, you can take steps to ensure you are dampening the negative impacts of inflation while making the most of opportunities it can present.

What is the current state of inflation?

Over the past year, consumers have seen higher prices for the things they buy most, like groceries and gas. From January 2021 to January 2022, the Consumer Price Index [CPI] rose by 7.5%, representing the fastest pace of inflation since 1982.

Increased prices can also drive wages higher. However, wage increases often lag behind prices, which has proven true over the past year. For the 12-month period ending in December 2021, wages increased 4.0%. This increase may seem significant, but it is far below the inflation rate. This means the average American has lost purchasing power due to inflation.

How Inflation Impacts Your Retirement Plan

Rising prices can put pressure on your current budget. However, it is important to remember that inflation will also impact your living expenses during retirement. Whether you plan to maintain your current lifestyle or increase your standard of living in retirement, you will likely need to save more to meet your goals.

Higher costs of living and slow wage growth can create a unique challenge for those saving for retirement. When you have less real income to work with, it can make it difficult to find the funds to set aside for retirement – often leading you to rely on investment gains to make up the difference.

How Inflation Impacts Investment Returns

Inflation not only raises the prices of everyday goods and services, but it can also have a major impact on your investments. While some securities might react poorly to high inflation, like growth stocks or bonds, other investments like banking stocks can actually gain value.

To make the most of rising prices, you should understand how inflation can impact different classes of investments:

The Impact of Inflation on Bonds

Income from investments with a set annual yield, like bonds, may become less valuable during periods of high inflation. When this occurs, investors demand higher yields from bond issuers to compensate for lost purchasing power. Bond prices move counter to bond yields, so when inflation pushes bond yields higher, resale prices for current bond holdings will fall.

Additionally, when inflation is high, the Fed will often tighten monetary policy. This is likely to be the case in 2022. When the Fed funds rate increases, it typically leads to lower bond prices.

In your portfolio, these factors could result in the resale value of your existing bond holdings falling. However, if you hold your current bonds to maturity and replace them with new bonds at higher yields, your bond income should grow over time.

The Impact of Inflation on Stocks

Typically, when inflation is high, so is consumer demand. This can mean that companies are selling more and bringing in more revenue. So, some stocks may perform better in a high inflation environment. Additionally, when rates rise to combat inflation, banks and other lending institutions generally see rising profits.

On the other hand, inflation increases costs for businesses. In inflationary environments, raw materials and labor costs for businesses grow, which can eat away at their bottom line and their profitability. This in turn, could negatively impact their stock prices. In addition, when the Fed raises rates to combat inflation, those higher interest rates can dampen consumer demand, which can also have a negative impact on stocks in impacted sectors. Higher rates are also seen as a negative for the valuation of growth stocks. Overall, inflation and rising rates can have a mixed impact on stocks and the impact is heavily dependent on sector and individual business structure.

What you can do to prepare your retirement plan for high inflation?

There are several steps that you can take to ensure your retirement plan is tailored to the current inflation environment. These include:

Track your Spending

Review your budget and compare it to prior years’ budgets to see how rising prices are impacting your current spending and saving habits. Maintaining a budget can help your retirement plan in two ways.

First, you can get an accurate estimate of how much you spend currently which can help you forecast your income needs in retirement. Second, keeping your monthly costs under control can help you free up more money for saving. And remember, bad spending habits can lead to bad investing habits.

Save More

As prices increase, your ideal retirement situation will become more expensive. To ensure that your savings will last through your retirement, save more now.

It can be helpful to set up automatic monthly contributions to your retirement plan and savings account to ensure savings are deducted from your account before you spend on discretionary items. In addition, be sure you are maxing out tax advantaged retirement contributions and company matches.

Work With Your Advisor to Evaluate Your Portfolio

Your investment returns could be impacted by the current inflation environment. However, that doesn’t necessarily mean that you should make changes to your portfolio. Your ideal investment mix should be based off of your risk tolerance, your current income needs, and your required rate of return. Discuss how inflation could impact these factors with your financial advisor and decide if any changes to your portfolio are warranted.

The most important thing you can do to plan for retirement is to work with an experienced financial advisor, like those here at Brookstone Wealth Management. A knowledgeable advisor can forecast how different inflation scenarios could impact your income needs during retirement and how the current inflation and interest rate environment could impact your investments.

Plan for a Successful Retirement with Brookstone Wealth Management

At Brookstone, our team of financial, legal, and tax professionals can help you develop strategies to reach your retirement goals, while taking inflation into account. We accomplish this with Financial Fingerprint™ – a comprehensive wealth management plan that is quick to assemble, easy to understand, and simple to modify as your circumstances change.

Our focus is on coaching, teaching, and mentoring our clients. With an advisor at Brookstone Wealth Management and your Financial Fingerprint™, you will have the tools and confidence to reach your True North.

Contact us today.