How To Start An Inflation-Proof Retirement Strategy
Written by: Samantha Butcher | Advisory Team
As financial advisers, we hear the word “inflation” quite a lot, but we find that not everyone understands exactly how it affects their long-term financial plans. We’re quite often asked:
“Does inflation impact my retirement plan?”
The short answer is yes, inflation can definitely impact your retirement planning, and it is something that should be considered when determining your retirement assets.
What Is Inflation?
Inflation refers to the gradual increase in the cost of goods and services over time, effectively decreasing the purchasing power of money.
For example, $100 today will buy you less than it did a year ago, let alone five or ten years ago. The inflation rate is not linear, in that it varies year to year. The long-term average inflation rate in Australia is 2.3%, but as we all saw, post-COVID-19, inflation hit nearly 8%!
Fun fact: In 1951, Australia hit a record high of 23.9%.
So, How Does This Affect Your Retirement Plan?
When working out how long your money is going to last, you need to factor in the cost of inflation on your expended investment returns.
If inflation is averaging 3% and a term deposit is earning 4%, the net return is actually only 1%. This could result in your money being depleted faster than expected.
Inflation is more of a problem for retirees compared to accumulators because retirees are relying on their investments to provide regular income. Inflation can also affect the value of retirement income streams, especially those that are fixed or not indexed to inflation. You will need to withdraw more to pay for the same level of goods and services, at a time when your investment returns are being impacted by higher inflation, reducing your capital at a faster rate.
Already retired but considering the benefits of financial advice? Check out this previous article we put together: Financial Advice During Retirement: Why You Might Need It
So, How Can My Retirement Plan Combat Inflation?
There are some strategies that can help mitigate inflation risk on your retirement savings:
- Equities
Stocks provide some protection against the long-term risk of inflation because their long-term returns on average are above the rate of inflation.
You may see some short-term volatility in the stock market when there are sudden spikes in the inflation rate, but over the long term, stocks will generate a return over and above inflation.
Value stocks tend to perform better than growth stocks in high-inflation environments. Long-term investments need to be able to generate a real rate of return that provides growth in the investment value, offsetting the impact of inflation over time.
- Diversification
Investing in a range of different asset classes and then also investing in a variety of assets within each asset class will help provide some protection against inflation because you will have exposure to a whole range of industries.
- Rebalancing
Regularly rebalancing your investment portfolio and making investment adjustments as required will also help provide a layer of protection against inflation. For example, you can buy and sell according to which investments are performing better in a high-inflation environment.
- Inflation-Protected Securities
You can purchase investments that automatically adjust to inflation, which helps ensure your funds do not lose any purchasing power over time. You can choose to have your income stream (annuity) increase with CPI every year to help reduce the impact of inflation on your cash flow.
A CPI-linked lifetime income stream sustains the lifestyle of the retiree by adjusting their payments with changes in the cost of living. However, if you have an account-based pension where the balance is market-linked, you will need to be mindful of not increasing your drawdown too heavily, as this will impact the longevity of your portfolio.
- Entitlement to the Age Pension
The age pension automatically increases by inflation twice a year, helping your income keep up with the increase in rising costs.
- Regular Financial Reviews
Review your budget on a regular basis and curb your discretionary (non-essential) spending in a high-inflation environment if necessary.
Seeking Financial Advice To Create Your Inflation-Proof Retirement Strategy
Seeking advice from financial advisers can help you navigate complex investment choices and tailor retirement plans to address inflation.
Financial advisers can structure your investments in such a way that you can receive income from multiple sources, in order to provide some hedging against inflation. For example, retirement income could be made up of a partial Centrelink age pension, a CPI-indexed annuity which provides guaranteed income for life, dividends, and/or a market-linked account-based pension.
Having a variety of income stream sources provides the diversification necessary to help combat the risk of inflation, reducing any negative impact on your lifestyle.
Choosing investments to help combat inflationary pressures will help everyone, regardless of their level of wealth. Individuals with smaller balances are dependent on their investments providing an income that keeps up with inflation (as a minimum) whilst maintaining the capital in order to pass down to future generations is important to individuals with higher balances.
Do you want to go overseas every year? Do you want to be close to home to help look after grandchildren? Do you want to travel around Australia in a motor home or caravan for 6 months every year? Do you want to volunteer at a local hospital, school or pet shelter? Or do you want to keep working on a casual or part-time basis?
Deciding on these things dictates how much income you will need from your retirement assets. You are then hoping that your starting capital will be enough to sustain your income needs for the rest of your life.
Superannuation is a crucial factor when discussing and planning for your retirement, but do you know how much you’ll actually need? Check out this previous article we put together: How Much Superannuation Do I Need For Retirement?
Canny Advisory + Retirement Planning
At Canny Advisory, we have a team of financial planners who specialise in retirement planning and will help you create a plan tailored to your needs. Together, we will devise a strategy suited to your specific goals and objectives, regardless of your starting balance. The first thing to do is to discuss what you want to do during retirement.
There are many strategies we can adopt to help curb the effects of inflation on your capital and help provide you with the lifestyle you deserve during your retirement years.
Get in touch with our team today, to start navigating what your retirement planning journey can look like.
