Tuesday, March 24, 2015

Is there inflation 'crabgrass' in your retirement planning? Deal with it.

"Inflation is the crabgrass in your savings," Robert Orben, (1927 - ) American comedy writer.

Editor's note: Here a new report from the Wall Street Journal about the rising cost of drugs for those in Medicare Part D, which is supposed to cover those costs. click here.

Believe it or not, a little bit of inflation is a good thing. It means the economy is perking along. It means consumers like you and I have the confidence to buy stuff. It means that producers and retailers can expand their businesses, add workers and hand out pay raises. That’s because they believe they can cover higher operating costs and still earn a profit by improving efficiencies and by raising their prices.

Inflation is a natural part of a functioning capitalistic society. (Just ask the Federal Reserve Bank). For the past gazillion years the average annual U.S. inflation rate has been running at about 2 percent. That means that a “market basket” of consumer items as determined and measured by the U.S. Bureau of Labor Statistics increases in cost by 2 cents per $1 every year.

Over time these small annual inflationary cost increases can take a serious bite out of your buying power, now and in retirement.

Let’s look at the Portland, Ore. metro area near my home. From 1987 through 2014, the annual inflation rate in Portland has been as high as 5.6 percent in 1990 and as low as 0.8 percent in 2002 and 0.1 percent in 2009. In 2014, Portland’s Consumer Price Index (inflation rate) rose an overall 2.3 percent.

Within that number, prices for specific items jump around.

Last year in the 12 months through December, food prices rose 2.8 percent while rental housing costs increased by 4.7 percent (mostly because of apartment rent increases). Energy costs dropped because of lower gasoline prices but those lower prices were mitigated the rising cost of electricity, which jumped 7.2 percent as utilities raised rates to cover the cost of new power projects in our region.

Inflation’s long-term impact

In Portland, a market basket of goods and services that cost about $100 in 1987 now costs $242! So over the long term, inflation eats away at our buying power. A great lament of our current economy is that wages in the past 10 years have not kept pace with the increasing cost of living. While prices for such items as food, energy and housing have been going up, employers have not been willing to raise employee pay. Now we are seeing more local and state governments take on the politically popular idea of raising minimum wages. (But I am getting off topic).

In reality, if you are NOT getting at least a 2 percent raise every year, you are losing ground to inflation. But even a 2 percent annual raise means only that you are treading water. If you haven’t received a raise in say, the past 10 years, you’ve lost about 20 percent of your purchasing power thanks to inflation and the rising cost of living.

Inflation in retirement

The same goes for those planning for retirement or who already are living in retirement. If your investments are not producing income of at least 2 percent a year, you are getting poorer. Thoughtful investors must take inflation into account as they figure out an ongoing retirement financial strategy. Like death and taxes, inflation is here to stay unless you live in Japan where prices have been in decline. Our Federal Reserve Banking System does NOT want that to happen. Deflation throws ice water on the economy ---consumers stop spending, producers stop growing and adding jobs.
Don’t ignore inflation, deal with it.

Tips from investment experts on managing inflation

- Balance investment safety with a reasonable return. The S&P 500 has provided a dividend yield averaging 1.92 percent a year for the past 30 years. Add on increases in share value and you’ve got nice asset growth over the long-term. Keep some cash in reserve so you don’t have to sell principle to groceries or a new car when stock markets are in decline.

- Consider Treasury Inflation-Protected Securities or TIPS bonds to guarantee a return that rises along with the inflation rate.

- Own real estate that over time increases in value. Your borrowed mortgage money gets cheaper as your home increases in market value, points out William Baldwin at Forbes.com.

- Consider buying individual blue-chip stocks with a good dividend of around 3 percent a year. Avoid high-paying dividend stocks…higher dividends mean higher risk.

- Delay Social Security and give yourself an 8 percent raise in benefits every year until age 70 ½. You get a bigger monthly retirement check, which is inflation-protected. Authors Larry Kotlikoff, Philip Moeller and Paul Solman have written "Get What's Yours: The Secrets of Maxing Out Your Social Security. You can download it for $10.49 to your Kindle or buy a hardcover for $11.99 special at Amazon.com. Click here.

For more:
"What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation?" click here.
"Smart Equities for Creeping US Inflation," click here.
"Seven Ways to Beat Inflation," click here.
"How to Deal with Inflation Risk in Retirement, " click here.

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