Inflation is a Real, Persistent, but Underappreciated Threat to Retirement Success
Driving with my dad the other day he said he needed to stop at a department store to buy some new pajamas. That led (somewhat invevitably when conversing with someone on the high side of his 85th birthday) to commentary on the rising cost of stuff. "Am I the only one who notices that the price of everything is sky high?" he asked. My answer could have been "Well dad, I'm sure it seems that way because you haven't actually bought anything since 1966!"
Another time he shared the carefully drawn up financial plan he had created back at the start of his career, circa 1959 or so. He had figured out that he could have lasting financial security if he owned his home free and clear and managed to save $10,000. We had a good laugh over that one. His plan might have been mathematically perfect, but for the missing variable of inflation.
From dad's perspective, with an 85 year time horizon, inflation is a very real and tangible thing. Not so for most of us. From day to day, we don't see the force at work. But once your income stops rising in retirement, you start to take notice. And with every year that passes, as you need to take more and more out of your savings just to keep standing still - it becomes more and more real.
Everyone focuses on investments as the biggest source of risk to their retirement portfolio. And sure, retirement is no place to be playing fast and loose in the stock market. But our financial planning software (and my dad) will tell you with no uncertainty that inflation is at least equal as a threat to your financial security.
But people tend to lose sleep worrying about what the market will do - not what the CPI is doing. Why is that? Well, I think it is because damage wreaked by a declining stock market comes at you in large waves, all at once, and is made clearly visible to you in your monthly account statement. Inflation, in contrast, unfolds slowly but persistently over long periods of time. Instead of hitting you over the head with a mallet, it simply drips, drips, drips until you realize you are drowing.
How do you combat inflation? Well, first, recognize it exists, and plan your retirement income stream accordingly. Second, make sure that a portion of your portfolio is devoted to assets which will grow faster than the rate of inflation over long periods of time. Remember, inflation unfolds over 10, 15, 20 or 30 years. The impacts are compounded year after year. The way to fight and defeat it is to have assets which will do the same thing in reverse - compound returns over long periods of time. Historically, stocks have been the asset that most consistently provide returns greater than the rate of inflation.
This video from Dimensional uses its newly released "Matrix Book" to shed some insight on inflation and investment strategies to combat it.