Rock House Financial Insights

Get our monthly newsletter that brings you news and tips from Rock House Financial.


diagram of increasing inflation

How to Protect Your Plans from Inflation

When planning for the future, it’s important to consider inflation. While we may not like it, life will be more expensive in 10, 20, and especially 30 years from now. Does your financial plan account for that?

Let’s say you are comfortably planning for a retirement income of $65,000 per year. That may look fine now. But 30 years from now, the purchasing power of that $65,000 might be just half (or even less) of what $65,000 will buy today. In other words, the net effect of inflation is that you could have the purchasing power of $32,500 or less per year three decades from now.

Does 30 years sound like a long time?

If you plan to retire at, say, age 65, you could realistically spend 30 years in retirement. A 1 to 2 percent annual rate of inflation can effectively erode your purchasing power and your ability to live comfortably within your financial plans. Even if your retirement is “only” 10 or 20 years, inflation will have an effect on what you can afford.

If you’re 35 and in the midst of planning for the future and how much you’ll need for retirement, inflation’s effects will be even more pronounced. Inflation can also have a more prominent effect on a high net worth retirement.

Let’s talk! Schedule a no-strings-attached conversation with the Rock House Financial team to see how we can help.

What is Inflation?

Inflation is the incremental rise in the cost of goods, assets and services over time. It’s caused by a number of factors, including businesses and other producers raising prices, the increase in the cost of raw materials and more.

Inflation is completely normal. The U.S. Federal Reserve sees a 2 percent annual inflation rate as acceptable – and says it can become even higher to spur high employment. (On the whole, however, U.S. Federal Reserve policy for the past several decades has been aimed at keeping inflation under reasonable control, using a number of strategies, including the direction of interest rates.)

The U.S. Federal Reserve aims to keep inflation in check for the same reason that individuals should be aware of its effects: Over time, inflation makes your purchasing power drop. What $5 buys today will not be what $5 buys next year, next decade, or especially 20, 30, 40 and 50 years from now.

How is Inflation Different than Cost of Living?

Inflation has several impacts on the cost of living, but they are not the same thing.

While inflation measures the increase in the price of goods and services, and therefore, the decrease in the buying power of the dollar, the cost of living looks at how much it costs to live in a specific area or lifestyle. For example, retirement in Utah may cost less than a retirement in California or New York, not because it costs more to create goods and services, but because it costs more to live in these areas (real estate prices may be higher, the availability of basic necessities like food may cost more to supply in different areas, and healthcare and wages could be higher or lower). Obviously, inflation affects the cost of living.

Inflation is often computed by looking at various cost sectors. Groceries, for example, can be compared by looking at how much an average basket of groceries cost in, say, 2016, versus how much the same basket of groceries cost in 2020. The same is true of utility costs, real estate costs, healthcare costs and more.

Cost of living, on the other hand, looks at how much that basket of groceries may cost in New York in 2020 versus in Utah that same year. When inflation increases, both baskets of groceries will become more expensive. Cost of living differences is why it’s also important to discuss your ideas for retirement with a financial advisor; not just the investment side of things but where you plan to live, what you plan to do and how you plan to fill your days. These will affect how much you need in retirement.

Social Security benefits and some pensions account for these increases to maintain a standard of living.

What Does Inflation Mean for Retirement?

Inflation affects people at all stages of their lives, but its effects can be particularly acute at retirement. The reason? Many retirees live on a fixed income. Ever-climbing prices can mean that folks on a fixed income are left further and further behind in maintaining their standard of living, because they are losing the purchasing power of their money.

It’s estimated than even a 1 percent inflation rate effectively loses an average retiree the equivalent of more than $34,000 over a 20-year period.

Even if the SSA enacts cost of living increases (which it does periodically), they may not be enough to keep pace with overall inflation for seniors. Why? Because many sectors particularly important to retirees experience higher than average rates of inflation. Healthcare is one. For the past several decades, increases in healthcare costs have outpaced the average inflation rate. But the SSA bases its cost of living increases not on healthcare cost increases, but on overall cost increases.

While healthcare is not the only sector where cost increases outpace the average inflation rate, it is virtually certain that retirees will need healthcare during their retirement, and perhaps a lot of it. It’s dangerous to go without as well.

How to Plan for Inflation

 Being forewarned is being forearmed! Once you know about the dangers of inflation to a financial plan, both in retirement and outside of it, you can start to plan for inflation’s effects. Here are a few tips:

1. Factor an inflation rate into your projections.

The average inflation rate runs from 1 to 3 percent per year. When you work with your financial planner to calculate how much you’ll need in retirement (and for any future plan), make sure to factor this into your final amount.

In other words, if you’re 35 and want to have the equivalent of $65,000 per year in retirement at 65, consider an erosion of 1 to 3 percent every year to your purchasing power and calculate the amount you’ll need to keep pace.

2. Develop an asset allocation to keep pace with inflation’s rise.

 Your retirement nest egg should follow an asset allocation that will allow the total amounts to keep pace with inflation (and hopefully, exceed it).

Effectively, this means stocks and other high-performing assets. Over time, the U.S. stock market as measured by the S&P 500 has returned an annual average of almost 10 percent over the last 100 years. Bonds and cash, by contrast, have seen their returns at 1 or 2 percent annually (or even near-negative) since the Great Recession of 2008-2009. At those rates, bonds and cash may effectively lose your portfolio money.

That said, bonds and cash are important sources of price stability, while stocks can exhibit volatility and drop during certain periods. Work with a financial planner to develop an asset allocation strategy that protects you from inflation.

3. Pay off your mortgage.

Purchasing a home can be a good hedge against inflation provided you obtain a fixed-rate mortgage. Obtaining a fixed-rate 15- or 30-year mortgage means that your housing costs are relatively locked in place for the duration of the mortgage.

Real estate prices can fluctuate, of course. The price of a home is not a guaranteed inflation hedge, because it can rise or fall. But the payment on a mortgage or rent is a large component of your monthly costs, at all ages. People who pay on a fixed-income mortgage have insured against the payment rising, while renters have not. Renters are at the mercy of real estate price inflation.

Once you have paid off your mortgage, you will have only property tax and maintenance costs, regardless of the price of the home. The lack of a mortgage or rent payment at that point will also serve as a partial hedge against inflation.

Finally, if your home price has increased over the duration of the mortgage, as it has in many areas of the country over the past several decades, downsizing at retirement may allow you to use the proceeds as a nest egg to protect you from inflation.

Inflation is a complicated concept, and planning for it can be tricky. If you have questions, contact the team at Rock House Financial. Locally owned and independent, Rock House Financial is passionate about helping clients create a more confident financial future. Our financial planners work as fiduciaries and offer fee-only financial planning, investment management and tax strategies to help you minimize financial stress and achieve your goals.

If you’re looking for a financial planner in Utah or want to make a change, let’s get a conversation started.

Rock House Financial eBook