How To Manage Inflation

The U.S. economy’s rebound from the pandemic is driving the biggest surge in inflation in nearly 13 years. If you’re concerned, you’re not alone. Retirees we recently surveyed told us that they fear inflation more than the rising cost of healthcare.

Following are some inflation considerations for your financial life, including your investment portfolio and your day-to-day expenses.

The Impact of Inflation on Your Investment Portfolio

Imagine you have $1,000,000 saved, and you live in a fantasy world where there are no taxes.

You need to take out $40,000 each year for expenses. This is a very reasonable 4% starting withdrawal rate, and it assumes you can get 5% a year risk-free and tax-free on your investments, with inflation at 3%.

Everything should be fine, right? Indeed, after 10 years your balance has grown to about $1.06 million and you feel comfortable. Then a funny thing happens. Your balance starts to decline, slowly at first and then faster. You are broke after 37 years.

What happened? Even though the rate of appreciation on your investments was higher than inflation, because the money you spent was not able to grow, the inflation rate on the expenses eventually overwhelmed the portfolio. Had inflation only been 2%, it would take 48 years to go broke. Only when inflation is down to about 1% does the portfolio continue to grow indefinitely in this scenario.

Inflation is the greatest destroyer of wealth in the history of the world. It will destroy much of yours as well. Do not underestimate it when you are planning, especially regarding asset allocation decisions.

Due to the power of compounding, inflation has a much greater impact in long-term horizons than it does in short ones. Especially if you have a long time horizon (more than 30 years), don’t assume that everything will be fine as long as your investment return is higher than your original withdrawal rate. If inflation rears its ugly head, even if your returns outpace it, you will still run into trouble.

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Disclosure: Free tools, such as the ones offered through Personal Capital, can give insight into your whole ...


