How to Stop Inflation Derailing Your Retirement Goals

The rising cost of goods has been a major concern for Australian households for some time now. And while inflation in Australia seems to be coming down from its unnerving highs, many of us are still struggling to adjust.

Inflation by itself isn’t necessarily a bad thing — in fact, low and predictable inflation is a normal part of a healthy economy.  In economists’ eyes, it is even preferable to prices falling, which slows economic activity as people put off spending in the hopes of getting a better deal in the future.

But when inflation surges beyond normal levels (and stays elevated for long periods of time), it can wreak havoc on household budgets.  The immediate outcomes — sharp increases at the petrol pump and supermarket checkout — are unwelcome.  Just as worrisome though can be the long-term effects on savings and, by extension, your retirement plans.

Why managing inflation risk is crucial in retirement

For individuals, the net effect of prices going up is the purchasing power of money goes down.  So, if the annual rate of inflation is 4%, that means $100 today will be worth $96 next year.  Over a long enough period of time this can put a major dent in savings — that is, unless investment returns are high enough to compensate.

One way to roughly calculate the impact of inflation is to use a formula known as the Rule of 72.  By dividing 72 by the rate of inflation, you can approximate the number of years before a sum of money loses half of its purchasing power.

Let’s say you had $10,000 sitting idle in a transaction account, not earning interest.  Dividing 72 by 4 gives us 18, which means it will take around 18 years for half the real value of that $10,000 to disappear — and that is without spending a cent.

This is especially pressing for retirees, who are no longer earning a salary and whose retirement plans depend on making their money last as long as possible.  If inflation outpaces the returns on your super and other investments, you might have to rethink your plans.

Ways to hedge against inflation and keep your retirement plans on track

Investing in growth assets

If your savings and investments are generating returns below the rate of inflation, you are effectively losing buying power.  Investing in growth assets can provide a greater chance to outperform inflation, although you will need to consider your investment horizon and the level of risk you are comfortable with.

Diversify your investments

While it generally pays in the long term to have exposure to investments that offer the ability to outperform inflation, a well-diversified portfolio of investments will help to provide consistent overall returns, reducing the impact of market volatility.

Bucket strategy

One way to help ensure long-term growth and shorter term cash flow needs are both addressed is to employ a ‘bucket’ strategy.  This strategy splits your retirement savings into buckets with different time horizons:

• A short-term bucket that contains enough low-risk, liquid assets to cover immediate expenses
• A longer-term bucket, containing a diversified exposure to defensive and growth assets.

The idea is to replenish the first bucket with the returns from the second, with the aim to provide regular income to live on while giving the majority of your savings the opportunity to grow.

Regularly assess your eligibility for pension payments and concession cards

Thresholds of eligibility for pension payments and concession cards are periodically increased.  It pays to regularly check your eligibility for pension payments and concession cards.  The extra income provided by qualifying for pension payments, and the reduction to living expenses provided by qualifying for a concession card, can help to make ends meet.

Use your offset account

If you have a mortgage, moving money held at call to an offset account can help to mitigate the effect of rising interest rates.  The balance held in an offset account reduces the amount of your home loan that is subject to interest.  Home loan interest rates are typically higher than the rate of interest provided by savings accounts and term deposits.  Holding funds in an offset account in preference to an interest bearing account can result in your money working harder and help to balance the household budget.

Manage your expenditure

Developing a budget to manage household expenditure can help to offset the effects of inflation.  While easier said than done during periods of high inflation, buying in bulk, taking advantage of sales and discounts, and rationalising discretionary expenses can have a significant impact on the bottom line.

Inflation is an unavoidable feature of the economy but mitigating its effects does not mean you have to abandon your retirement plans.  With the right strategies in place — and a willingness to be flexible and proactive — you will be able to ride out periods of high inflation and make your retirement savings last.

If you would like to discuss the strategies mentioned in this article, or to understand how they currently being deployed as part of your finances, please contact our office to arrange a time to meet and discuss.