Hello, inflation: It’s true, sticker shock is happening everywhere. Prices have risen 5% or more compared to the prior year for three consecutive months, according to the Consumer Price Index (CPI). That’s notable especially considering that the inflation rate never rose above 2.9% between 2012 and 2020.
Inflation’s impacts on retirement savings: While this spike is only temporary, it can still impact retirement savings growth in two major ways: (1) Inflation increases business costs, which can limit earnings and stock appreciation and (2) inflation limits the purchasing power of your 401(k).
Investor strategies: Even though you can’t stop inflation, you can hedge against it. For one, you can save more. Savings extra dollars will mitigate the hit to your purchasing power.
Consider dividends: Another way to hedge against inflation is to invest in dividend paying stocks. While you are still working and saving, you can reinvest these dividends. After you retire, these dividends can transform to a source of income. When selecting a dividend-paying stock, consider the company’s profitability over time, its cash flow, and if it has a history of rising dividends.
Invest in buckets: By segmenting your savings into three buckets, you can have your cake and eat it too. In other words, you can feel comfortable investing aggressively even as you close in on retirement, all the while hedging against a short-term liquidity crisis.
Bucket #1, a cash account: Your short-term savings should be able to cover two years of living expenses if you are near retirement. If you are more than ten years from retirement, you can keep the balance such that it only covers six months.
Bucket #2, medium-term funds: This bucket should include high-quality bonds, stable value funds, blue-chip stocks, and reliable dividend payers. Arrange this account such that it covers 10 years of living expenses.
Bucket #3, growth stocks: This bucket can handle volatility and can include exposure to small-caps, mid-caps, and international markets.
Try all three: There’s no avoiding inflation, but with the right mix of retirement strategies, you can minimize its impact on your long-term financial outlook.