Inflation has been a hot topic for months and likely will be well into 2022. Its impact is immense; with inflation at its highest level in 40 years and interest rates rising, consumer sentiment is falling.
As we come to grips with rising costs for goods and services, it’s also important to understand a concept called shrinkflation, which is common during periods of high inflation and further fuels pessimism and anxiety about the economy.
Shrinkflation is when companies give you less for your money to compensate for their rising production and supply costs. Rather than raise the product’s price, which most customers would notice immediately, companies downsize the product. For example, a slightly smaller box of cookies for the same price you’ve been paying isn’t as readily detected by some consumers unless you read the fine print. There are all kinds of examples of product manufacturers engaging in shrinkflation.
Inflation is always a concern during retirement. Even more so now at its highest level since 1982. A Fidelity Investments study shows that 71% of American investors are very concerned about how inflation can impact their preparedness for retirement.
Historically, evidence indicates that inflation will come back to earth; annual inflation rates since 2000 in the United States have usually stayed under 3%. Even so, planning for inflation is imperative when building your retirement plan. Make sure that you’re incorporating some projection for inflation and what it will cost to maintain your lifestyle in the future.
While the stock market is one of the best vehicles you can use to help offset inflation, that approach also involves a high level of risk. One way to mitigate that risk while protecting against inflation is to set aside a certain number of years of income in a vehicle meant to produce additional income in retirement. If you’re within five to 10 years of retirement, it’s prudent to have such a bucket set up.
Here are some ways you can do that and plan your hedge against inflation in retirement:
Create a CD ladder
This is a savings strategy in which you invest in several certificates of deposit with staggered maturities. This allows you to capitalize on higher rates on longer-term CDs and keep some funds accessible in the short term, although early withdrawal penalties could apply.
CDs offer a guaranteed rate of return, and if rates are rising, you can reinvest the money from shorter-term CDs into new accounts to lock into higher annual percentage yields. You could, however, be missing out on higher returns from more aggressive investments, such as stocks and bonds.
Build a bond ladder
People build bond ladders to create predictable income streams while managing potential risks from changing interest rates. Interest payments from bonds can provide income until the bonds mature or are called by the issuer. Laddering bonds that mature at different times allows you to diversify the risk of changing interest rates across several bonds.
Keep in mind that ladders should be built with high-quality, noncallable bonds. With interest rates likely to keep rising in 2022 as the Federal Reserve acts against inflation, a bond ladder can be useful in this scenario because it regularly frees up part of your portfolio to take advantage of the higher rates. However, investors need to be aware of bond-related issues, such as risks associated with diversification and default, as well as relatively high costs.
Consider a fixed index annuity
A fixed index annuity is an insurance contract that provides you with income in retirement. Payments are based on stock market index returns, such as the Dow Jones Industrial Average or the S&P 500.
You don’t have to worry about large losses with a fixed index annuity during a significant market downturn. Unlike directly investing in the stock market, you’re generally protected against losses. But that comes at a cost: Your total returns will be limited, and your contract may charge additional fees. On the plus side, the long-term expected return of a fixed index annuity is higher than other guaranteed accounts, such as a fixed annuity or CD.
The amount of income you’ll need in retirement will dictate what type of vehicle you use. Sit down with a financial adviser to talk more about your situation to figure out your best course of action for hedging against inflation.
Dan Dunkin contributed to this article.