Retirement planning - the impact of inflation

Matt Tod, Associate Partner, Wealth Management, Findex.

OPINION

For investors, inflation has played a leading role in financial market volatility over the past year.

While not the only influence on markets, inflation has been at the forefront of investors, policymakers, and Reserve Bank decision-makers’ minds over the past year.

The Reserve Bank of New Zealand manages New Zealand’s monetary policy to ensure consumer price inflation remains in a tight band of 1 per cent to 3 per cent. In its latest announcement on May 24, the Reserve Bank raised the official cash rate by 0.25 per cent as it continues to tighten monetary conditions to move inflation into the targeted band.

Inflation, the gradual increase in the price of goods and services over time, is an essential factor to consider when planning for retirement. As individuals prepare to leave the workforce and rely on their savings and investments, understanding the impact of inflation is crucial for maintaining a comfortable and secure retirement.

One of the primary ways inflation impacts retirement planning is by eroding the purchasing power of money over time. As prices rise, the same amount of money buys fewer goods and services. This erosion can significantly impact retirees who rely on fixed sources of income as their purchasing power gradually diminishes. It is essential to account for inflation when estimating future expenses to ensure that retirement income keeps pace with rising costs.

Inflation risk is particularly significant for retirees due to the potentially extended length of their retirement years. With advances in healthcare and increasing life expectancies, individuals are spending more years in retirement. This extended time horizon means retirees face a higher risk of experiencing the compounding effects of inflation over an extended period. Failure to consider and plan for inflation can result in a significant reduction in the real value of retirement savings over time.

Strategies to mitigate inflation’s impact:

Invest for growth: Allocating a portion of retirement savings to growth-oriented investments, such as stocks and equity funds, can help counter the effects of inflation. Historically, equities have demonstrated the ability to outpace inflation over the long term. However, it is essential to consider individual risk tolerance and adjust the investment portfolio accordingly.

Diversification: A diversified investment portfolio can help mitigate inflation risk. Spreading investments across different asset classes, including stocks, bonds, real estate, and commodities, provides potential protection against inflation’s impact on specific sectors or asset classes. Diversification can help balance risk and enhance the potential for overall portfolio growth.

Regular portfolio review: Periodically review and rebalance your investment portfolio to ensure it aligns with your retirement goals and risk tolerance. As retirement approaches, gradually shift to a more conservative allocation to protect capital. However, maintaining a balance that allows for growth potential remains important to combat inflation over the long term.

Budgeting and flexibility: Implementing a realistic budget and practising disciplined spending habits can help manage the effects of inflation. Regularly review expenses and adjust as necessary to accommodate rising costs.

While investors and retirees begin to benefit from higher term deposit rates on offer, consideration must be made to your investment time horizon. Short-term interest rates react quickly to changes in economic conditions within an economy and may not always meet long-term needs.