Inflation is the increase in the cost of goods and services that can erode your purchasing power. According to the National Education Association, teachers nationwide are losing ground to inflation; the average salary increase nationwide for 2007-2008 was 3.1%, versus a 4.3% inflation rate.*
And if you think inflation hurts when you are still employed and get regular raises, think of the impact when you are living on a fixed income.
Rates of Inflation
The United States has enjoyed many years of stable and historically low inflation. Over the past decade – until 2008 – annual inflation ranged from a low of 1.6% in 1998 to a high of 3.4% in 2005.**
However in 2008, inflation roared up to more than 5%, due to significant increases in the cost of food, energy and health care. This is even tougher news for retirees, since food, energy and health care typically comprise the three greatest non-housing expenses for retirees.
Safeguarding Your Nest Egg
As tough as inflation can be on daily living expenses, it can be like a wicked silent tax on your retirement nest egg, gradually eroding its purchasing power over time.
At an inflation rate of 3% annually, a nest egg of $100,000 would be worth $55,000 in 20 years ($41,000 in 30 years). If inflation increased to 5%, a nest egg of $100,000 would be worth $38,000 in 20 years ($23,000 in 30 years).***
Of course, no one likes to see their purchasing power dissolve. However, you can proactively take steps to protect your nest egg from inflation.
Stout Inflation Buffers
To help safeguard your nest egg against inflation, consider the following:
- Invest in stocks and stock funds. Although past return is no guarantee of future performance, stocks typically outperform all other asset classes over the long term. Since 1926, U.S. large cap stocks have returned 10.4% annually, easily exceeding the average inflation rate.*
- Treasury Inflation-Protected Securities (TIPS). Available directly from the U.S. Treasury at www.treasurydirect.gov, TIPS provide direct protection against inflation. The principal of TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When TIPS mature, you are paid the adjusted principal or original principal, whichever is greater.
- Inflation-resistant investments. Certain industries, such as food and non-durable consumer goods and health care, are generally inflation-resistant. Companies in these industries may be attractive investments. Although people might put off buying a new car during high inflation, they generally won’t skip eating or using toothpaste.
Remember – inflation can be a silent threat to your long-term financial security. Choosing investments that are too conservative may not allow your retirement savings to grow enough to outpace inflation. Remember to consider your financial goals, your timeline (how long until you retire) and your risk tolerance (how much you can handle the ups and downs of the market) when deciding on your 403(b) plan investments.
* Source: National Education Association press release, Dec. 18, 2008, www.nea.org.
** Source: “Ibbotson® Stocks, Bonds, Bills, and Inflation 2008 Yearbook,” Morningstar®.
*** Source: http://observationsandnotes.blogspot.com/2013/04/what-will-1-be-worth-in-future.html.
The Impact of Inflation on Your Real Rate of Return
Inflation – as measured by the Consumer Price Index – is the increase in costs of a basket of goods and services each year. You need to take inflation into account when deciding on your investments. Very conservative investments – such as fixed annuities – may not offer a rate of return high enough to outpace inflation. Let's take a look at an individual who invested $10,000 in a fixed annuity earning an average annual rate of 3% for 20 years, from 1989 through 2008, compared with the returns in large company stocks during the same period. From 1989 through 2008, large company stocks returned a high of 37.6% (in 1995) and a low of -22.1% (in 2002), but over the 20-year period the average annual return was 8.4%. Inflation during the period averaged 2.8%.*
Safeguard Your Nest Egg from Inflation
* Source: 2009 Ibbotson® “Stocks, Bonds, Bills, and Inflation®” (SBBI) Classic Yearbook. Return of large company stocks is based on the performance of the Standard & Poor’s 500 Index for the period 1989 through 2008. Individual investors cannot invest directly in an index. Past performance is not an indication of future results.