The 7 Deadly Retirement Sins, Part #1
Lack of inflation protection
What most people don’t realize is that there are many risks to their retirement portfolio. After a dramatic market decline, many retirees will move their stock portfolio to either cash or bonds. They are afraid of losing any more money and want to protect themselves against their most obvious risk: Market Risk. However, market risk is not the only risk your portfolio faces. In fact, there are several.
The risk that many retirees usually fail to recognize is the risk of inflation. Inflation risk is usually the opposite of market risk. But before we talk any more about inflation, let’s define it.
Inflation: The gradual increase in prices over a time.
Makes sense, doesn’t it? What did you pay for a movie in 1980? How much was a stamp in 1992? How about a gallon of milk in 1975? We all know that the prices for these items were much cheaper years ago. Gradually, prices increase with time. In fact, if you take a measure of all the goods and services in our country and track their increase in value over the past 50 years, you will see an average of a 3.5% annual rate of inflation. This increase may not impact you too much next year when your property taxes go from $10,000 per year to $10,350, but what about the year after that…then the year after that. In a matter of only 5 years, your taxes will rise from $10,000 per year to almost $11,900. In 10 years your taxes will be $14,105!!
The point is that your expenses will increase every year and traditionally bonds and cash have a poor track record of keeping pace with inflation. Unfortunately, in an effort to protect themselves from the short-term volatility of the stock market, the retiree that runs to bonds and cash during turbulent times is creating a long-term inflation problem for themselves. It is never advisable to solve a short-term problem by creating a long-term one.
Solution: The solution to this is simple. A diversified portfolio of stocks, bonds, and cash will reduce the volatility of a turbulent market while outperforming inflation over the long-term. Managing inflation can be tricky. I highly recommend that you work with a professional financial planner and money manager that is capable of managing all of your risks, not just market risk. A good money manager will be able to provide you with the inflation hedge you need while protecting your assets from the major swings the market can sometimes offer. Most importantly, an experienced financial planner and money manager will give you objective and logical advice during dramatic market swings that can keep you from getting emotional about your money.