Personal Investor: Will inflation swallow your retirement savings?
Of all the potential risks to our retirement savings, inflation has only been simmering on the back burner – at least for now. With Canadian inflation topping two per cent in April – that simmer could heat up to a boil.
Inflation is still tame by historical standards but contrast that with 1980 when it topped 12 per cent, and it’s not hard to see how vulnerable our retirement nest-eggs are.
One of the big changes adding to that vulnerability is the decline of defined benefit pension plans, which guaranteed regular payouts often indexed to inflation. Most Canadians now save for retirement by investing directly in the market or through their own employer-sponsored defined contribution plans, with no consideration for the rising cost of living.
In those cases the only thing investors and their advisors can do is estimate future inflation and subtract it from estimated rates of return. Most retirement calculators average in a three per cent annual increase.
Inflation is something every investor and their advisors should prepare for, but for now here are a few things to keep in mind:
- Inflation is a symptom of rapid economic growth, which is usually reflected in higher stock prices as corporate earnings rise. If you factor in future annual equity returns of five per cent, for example, inflation could boost those returns – which would help maintain a five-per-cent real rate of return. Talk to your advisor about investing in stocks that respond well to inflation.
- Canada Pension Plan (CPP) and Old Age Security (OAS) benefits are indexed to inflation. If inflation rises by eight per cent in a future year, benefits are increased by eight per cent. Extending the CPP has been a hot button political issue and it’s something to think about next time you vote.
- If inflation is a concern, part of your savings can be diverted to an annuity – an insurance product that guarantees regular payments like a defined benefit pension plan and can be indexed to inflation.
- You can protect the fixed-income portion of your portfolio against inflation with real return bonds (RRBs) - Government of Canada bonds that pay you a rate of return that is adjusted for inflation. RRBs pay interest semi-annually based on an inflation-adjusted principal, and at maturity they repay the principal in inflation-adjusted dollars. You can buy RRBs for as little as $1,000 through most securities dealers.
- There’s one other natural inflation hedge for retirees that you won’t hear about from the industry because no one makes any money. As we get older we slow down, and so does our spending. If you maintain a consistent budget into retirement, the money you don’t spend could be enough to ward off inflation.