By Adam K. Wright, CFA®, CFP®
Inflation was a big buzz word in 2022, and for good reason. It affects purchasing power, and can setback retirement plans, but inflation has had other side effects as well, as the Federal Reserve has consistently been raising the prime interest rate in an attempt to combat inflation and stave off a recession. Finally, safer investments are yielding a decent return, retirees are no long forced to the stock market for return.
The big question, as we head into a new year, is how will inflation impact your retirement plan?
What Is Inflation?
According to Investopedia, inflation is a decrease in the purchasing power of money, reflected in a general increase in the prices of goods and services in an economy. It can be characterized as persistent or transitory. Transitory inflation is temporary and happens when supply doesn’t meet demand. If left unhandled, it can turn into persistent inflation, which results in a more permanent increase in prices due to a continuous mismatch in supply and demand.
The Consumer Price Index (CPI) is a common measure of inflation. The most recent CPI report from November 2022 reveals the annual inflation rate is 7.1% (and 2021’s annual inflation rate was 7%). These are significantly higher than the typical 2% rise we see in an average year.
Why Is Inflation So High?
To better understand if inflation will last, let’s take a look at the factors contributing to its rise.
When the COVID-19 pandemic first hit and millions of Americans were furloughed or laid off, drastic economic measures were taken to keep the country afloat. The U.S. government instituted expansionary monetary and fiscal policies in order to pump money back into the economy, increasing the money supply at a rapid rate. Though experts agree that these drastic measures were necessary to keep the economy from collapsing, they also agree that the increase in money supply devalued the dollar, meaning it takes more dollars to buy the same item since each dollar is less valuable.
However, with the Federal Reserve’s consistent interest rate hikes, the dollar has gained some ground in 2022. If the interest rates keep going higher, the dollar could continue to gain ground.
Supply Chain Headaches
Supply chain disruptions caused a shortage in raw materials, thereby exacerbating the gap between overall supply and demand for even basic items. As demand continued to outpace supply, prices were driven higher and higher.
As supply chain issues waned in 2022, retailers found themselves with too much inventory that was no longer being demanded by consumers. This brought some holiday discounts for consumers, and some positive news, with retail sales rising 7.6% at the end of 2022.
Labor Shortages and Increasing Wages
Continued labor shortages are another factor driving inflation as Americans are reevaluating the role that work plays in their lives, working in an office versus working remotely, and their overall pay. As such, many companies are finding that they have to pay higher wages in order to attract and retain employees. These increased costs often get passed through to the customer in the form of increased prices for goods and services.
The flip side of the labor shortage issue is the passage of the $15 federal minimum wage, as many states followed suit with increases to their respective minimum wage thresholds. So even if companies weren’t paying more for labor because of the struggle to find workers, they would still be paying more due to increasing minimum wage. Again, these increased costs will be passed through to consumers, and it will be more than just a transitory change in prices since the minimum wage laws are permanent.
How Long Will Inflation Last?
It’s tough to say exactly how long inflation will last, but based on these three variables, it could be a couple years before we return to the target rate of 2%. As our global economy shifts, trade alliances change, and we experience the lasting effects of the COVID-19 pandemic, it seems to be an issue that will persist for the foreseeable future.
How Inflation Disrupts Retirement Planning?
A major goal for nearly everyone is to fund their retirement. If, it’s a faraway liability, worrying about how much more healthcare will cost are not things we tend to worry about today.
For instance, a long-term issue is getting ready for retirement and realizing you’ll need to spend $50,000 on healthcare but can only afford $35,000. After 30 years, and assuming healthcare costs keep rising at their historical rate of 4.15% per year , then $1,000 in healthcare costs today may only buy 1/3 of the care in the future. Nevertheless, when retirement planning, most want to be able to maintain their lifestyle or even grow it. Inflation is the slow drag that might keep you from reaching that goal. So, you want investments that do better than inflation to maintain your lifestyle. That means owning stocks and sometimes a lot of them. But stocks come with a lot of volatility. That’s a today worry, a short-term worry.
How Should Your Retirement Plan Respond to Inflation?
It’s understandable to be concerned about inflation. You’re likely asking, “How will inflation impact my current finances?” and “What about my retirement?” With a specialization in helping people retire, our team of CERTIFIED FINANCIAL PLANNER™ professionals will help you thoughtfully craft a retirement plan that answers all your questions. Then we’ll help you stay on pace to get where you want to go. If you want to create a financial plan that combats inflation and puts you on track to retire, schedule a complimentary phone call to get started.
Adam Wright is a CERTIFIED FINANCIAL PLANNER™ professional at Wright Associates, helping clients plan and prepare their investments to retire on their terms. If you’re serious about planning for your retirement and investing for your future, his annual process will help you make the right money choices today. Therefore, Adam and his team will proactively manage your accounts while communicating the progress of your financial plans. He believes the retirement advice you receive should be intentional and actionable.
Adam has a Bachelor of Science in Supply Chain and Information Systems from The Pennsylvania State University and a Master of Business Administration from University of Pittsburgh, Katz Graduate School of Business. He lives in Upper St. Clair with his wife and two children. When he’s not working, Adam enjoys the outdoors (fly fishing), reading, and taking long runs while listening to a favorite podcast. He’s also currently encouraging himself to take up golf. To learn more about Adam, connect with him on LinkedIn.