With the uptick in inflation this year, clients have become increasingly concerned about the impact of inflation on their retirement savings. The most frequently asked question many advisors are hearing lately is, “What adjustments to my retirement savings/strategy/lifestyle do you recommend I make to help ward off the rise in inflation and any impact on my income?”
To create a game plan, advisors must begin by looking at each client’s lifestyle along with their financial picture. Individuals experience inflation in their own unique way because they consume differently, so recommendations for heading off or mitigating the effects of inflation are not a one-size-fits-all solution.
What follows are some steps advisors can take to position clients for the best possible outcome.
Match Consumption with Withdrawal Rates
Before focusing on ways to protect a client’s investments and income from inflation, an advisor should have a conversation with the client about their consumption pattern and how it matches up with their retirement income withdrawal plan.
One frequently recommended withdrawal plan for retirees is the 4% annual income withdrawal rule (with the rate adjusted annually for inflation). In some cases, this plan will work as expected, but in other years clients may find their annual income distribution falling on either side of their expenditures. The 4% rule sound good in theory, but in practice each client’s lifestyle is unique and forever changing. That’s why applying one rule to all is not necessarily the best option. Instead, recommending a flexible consumption and withdrawal plan (i.e., taking more when markets are doing well and less when they are down) can help better match consumption with income while working to offset inflation pressures.
Time Social Security Benefits
Advisors should also address Social Security benefits with clients to help them improve income and protect against inflation. Social Security is really the only inflation-protected income stream that offers yearly cost-of-living adjustments (COLAs). Discussing the advantage of delaying the claiming of benefits until full retirement age or longer can be quite rewarding to the recipient. Delaying the claiming of benefits adds roughly 8% for every 12 months that benefits are delayed past full retirement age.
This year, the government has anted up and added a 5.9% COLA adjustment (the biggest increase in 40 years) to Social Security to go into effect in 2022. Some of the COLA increases are diminished by the rising cost of Medicare Part B. But even with healthcare costs cutting into the COLA, Social Security benefits still increase and can provide recipients with at least a partial offset to the rise in inflation.
Real estate is often looked at as a sound inflation hedge and income provider. Owning a home, unlike renting, may help insulate against a rise in inflation. Some would-be homebuyers remain skittish, though, because home expenses are not necessarily shielded from inflation pressures. For example, the costs of utilities and home improvements (labor and supplies) are likely to increase. Yet historically, a smart investment in real estate offers the ability to hedge against inflation in an asset class that typically maintains or increases its value over time and can serve as an integral part of an investor’s portfolio.
In inflationary times, advisors often recommend clients “de-risk” their investment portfolios and turn to cash and bonds rather than stocks to build a buffer against a rise in inflation. The problem is, cash and bonds provide a fixed-income payout but generally will not keep up with inflation. Interest rates rise during inflationary periods, pushing bond values downward. Investing in high-yield securities is sometimes recommended, but when inflation rises economic conditions typically become constrained and result in a negative effect on credit.
A safer alternative are Treasury Inflation Protected Securities or TIPS, an investment vehicle that provides an inflation offset. The principal value of TIPS will move up with the rate of inflation, as does their yield. Currently, TIPS yields are negative due to low interest rates, and they’re less liquid than U.S. Treasury securities — but their price appreciation and overall return can provide a mechanism to keep up with inflation.
Lastly, investors typically pare back stocks positions in portfolios during inflationary periods. Like bonds, stocks typically deliver constrained returns when inflation is high. Over time, stocks usually out earn inflation, but can be a lot more volatile than bonds. One option is to purchase dividend-paying stocks, including preferred stocks that offer a good defensive option, namely income, during inflationary periods. Increased income, whether from higher coupon bonds or higher dividend-paying stocks, works to offset price declines on securities during inflationary periods.
So when you’re asked, “What adjustments to my retirement savings/strategy/lifestyle do you recommend I take to help ward off the rise in inflation and any impact on my income?” my advice to advisors is to take a more holistic and tailored approach with your client. I can’t stress enough that one size does not fit all.
Becky Gersonde is vice president of Heber Fuger Wendin and currently advises banks, credit unions, foundations and individuals. Established in 1934, Heber Fuger Wendin is an RIA based in Michigan specializing in fixed-income investments for institutions and individuals.