Navigating retirement in the time of inflation

The current economy is like a hurricane — loud, volatile and the result of multiple pressure systems converging to create a perfect storm. What comes next will be of great importance to investors, particularly those already in retirement or saving for it.

We believe that inflation will begin to moderate as the pent-up demand that occurred in the aftermath of COVID-19 subsides. During the pandemic, we experienced an unprecedented shutdown of the economy while demand bottomed out. Meanwhile, the supply of goods and services shrank for a number of reasons, not the least of which was hiccups in global supply chains. As the lockdowns eased, consumer demand for those goods and services began to climb — but the supply was still lacking. This presented a textbook "too much money chasing too few goods" scenario, one that historically results in higher inflation. In this case it was further fueled by an excess of free money in the economy from stimulus checks and near-zero-interest loans.

However, all storms eventually blow over. As supply chains have opened up, factories have started humming to life and workers have returned to their offices. The much-discussed "new normal" is in sight, and while we may not go back to levels of benign inflation soon, it's doubtful that a 9% rate will sustain itself much longer.

Still, inflation remains a major concern for millions — not only because it lowers purchasing power but because of its effect on the stock market's volatility. As a result, many pre-retirees and retirees worry about how the market's current conditions might impact their funds.The good news is that there's a lot that advisors can do to help clients protect themselves.

The hybrid retiree
The flexibility workers enjoy today is unprecedented. As such, clients in or close to retirement should consider a hybrid arrangement, one in which they work part time, perhaps from home. In addition to helping them adjust socially and psychologically to this significant life change, it will also smooth the financial transition by taking some pressure off their retirement portfolio. 

In the meantime, advisors can help clients craft retirement income plans that take inflation into account. Most savers think in terms of replacing their current paycheck without considering that the purchasing power of their salary will be far less years from now. A decade or more into retirement, that "paycheck" may need to be 50% to100% higher, depending on the rate of  inflation.

Inspect expenses
People are always concerned about costs, except when there's plenty of money. We've seen this in the housing market recently, with realtors claiming that they could put a house on the market and have multiple offers in hand within 48 hours — some well above asking price. That was a direct result of Americans having lots of money they saved during the pandemic that could then be leveraged with cheap mortgage debt.

Inflation has changed the mindset. 

Creating margin in our cash flow is necessary, especially now that the record savings produced by COVID-19 lockdowns and stimulus have evaporated. The first question we ask clients approaching retirement is, "How much income do you need?" Oftentimes, all we get is a blank look and a response along the lines of, "I don't know. We live on a certain amount of money, we don't really budget."  

That must change. Investors need to examine what they spend every month to get an accurate baseline for their post-retirement monetary needs. To do that, they must understand where their money is going, which means taking into account budget leaks in bank accounts such as auto-renewal subscriptions for premium music, television, podcast services and the like. Automation has been a great convenience, but it's also made us less conscious of our spending. Many people likely have hundreds of dollars leaking from their budget and don't even realize it.

Avoid risky investments
The traditional 60/40 rule — an allocation to 60% stocks and 40% bonds — worked well until zero interest rates came along. Zero interest is bad news for the most risk-averse investors, but there are some opportunities in fixed assets now that interest rates are rising. Fixed-rate-of-return instruments such as annuities are more attractive now than they were even a few months ago. There are five-year fixed annuities in the 3% to 4% range that can act a lot like a bank CD for clients. No one should currently be blindly chasing yield. Instead, they should worry about the return of their money before the return on their money. 

Right now, interest rates may be artificially low because investors are betting the Federal Reserve will lose its nerve as an inflation-fighter. Low rates will help some consumers in the short term, but their collective fist will remain clenched, as we saw with decreased spending on consumer goods in July. In the long term, we expect that consumer staples will likely do very well, while consumer discretionary will likely suffer. Americans tend to protect the four walls of their financial house: food, clothing, transportation, shelter. Expect them to prioritize taxes, insurance and other unavoidable expenses over the next twelve months.

Stay (largely) invested in stocks
In this fraught economic environment, it may seem counterintuitive to advise clients to invest, or to stay invested in, stocks, but equities and real-estate are the only two asset classes that have historically outpaced inflation. If your client is one of the 90 million Americans in or nearing retirement, it's crucial to keep in mind that their proximity to their retirement date is not necessarily their investment horizon. Rather, the proximity to the end of one's life is their investment horizon. 

No one wants the money they need for next year's income to be invested in stocks this year, but clients will nevertheless need investments that offset inflation. This is where equities play a critical role. Even in times of benign inflation, the prices of some equities can double within a decade. As such, we continue recommending equities and real estate as a portion of a portfolio, even for our clients in their 70s and 80s. 

But in the short term, they should consider ways to best conserve and protect their assets. In other words, they must ensure they're prepared to ride out this storm.