With inflation really rising for the first time in years, many Australians are worried about whether their money will last through retirement. It’s fair to say that the level of concern is in direct proportion to their timeline to retirement—millennials aren’t nearly as worried as their parents. The parents, nearing retirement age, have never really lived through inflationary times—at least as adults.
Over the last 25 years, the average rate of inflation has been 2.4% per annum, and some years—2017 and 2018, most recently—the inflation rate actually declined. So when your morning latte goes up a few cents, or it costs another couple of dollars to fill your tank, the increases are so incremental that you hardly notice. But when you scroll through the morning headlines and see that inflation in December 2021 hit 3.5%, it does get your attention more than a few daily dollars.
What is inflation?
In a nutshell, inflation is a benchmark that measures changes in consumer prices, typically as they increase. What you may remember from Econ 101 is that supply and demand is the base layer, if you will, of a free market economy and that prices rise and fall with those two factors. Obviously, a first world global economy is more complicated than that, but that’s the gist of it.
What causes inflation?
In 2022, supply chain weakness from the Covid pandemic and geopolitical uncertainty are the primary drivers of inflation, but pent-up consumer demand is also contributing to higher prices (new cars are a great example—electrical chip shortages are decreasing supply, prices for used cars are astronomical, and rising interest rates make both more expensive).
Building inflation into your retirement planning
Human nature being what it is, your natural inclination is to just let your super account do all the heavy lifting when it comes to retirement, so you have more disposable income for those pricey new cars. And many Aussies also count their company pensions in that retirement equation, thinking that between those two institutional plans, you’ll be fine financially during your golden years.
The problem with that line of thinking is that these days, your golden years are likely to roll into a platinum level. Life expectancy is rising, so if you’re relatively healthy and retire at 65, you could expect to be around another 25 or 30 years. Is your super and pension balance high enough to maintain your standard of living, and are they even enough to live as long as you do?
Managing retirement risk for inflation
There are two elements to your retirement planning—your super and the investing you do individually, you need an experienced financial advisor to guide you through the maze of investment options. One thing to keep top of mind is that that your super is not meant to provide a deluxe standard of living in your retirement, rather, it’s there to supplement your other sources of income—you should really consider your super as a hedge against inflation if your other investment streams turn to a trickle. Super investments are super conservative for a reason—they’re basically a stopgap.
Personal investing
Smart investors also put money away on their own—real estate, bonds, and shares, to name a few. These instruments are not only the way to build wealth, they also can be structured in a way that walls off inflationary pressures.
How this happens is primarily on how far out your retirement horizon is—if you’re just starting out, your investments can be more aggressive (therefore more volatile and risky) than if you’re considering retirement during this current inflationary period. Only you and your financial advisor can assess the risks you should take with your retirement money.
Revise your budget
One thing to consider when you’re structuring your retirement income is that for most people, your expenses are a lot lower than when you were at your peak earning years. For one thing, your housing expenses are probably lower—you’ve either paid off a mortgage, or sold your family home and downsized with a cash purchase or much smaller mortgage. Also, you’re not raising your kids anymore, which means a good-sized raise every time a child goes out on their own.
Sequencing risk for inflation
Timing is everything, especially when it comes to retirement planning. It’s critical that you plan for some periods of inflation during your retirement—you don’t want to have to dip into capital to ride out high prices. Risk sequencing is the science of assessing your estimated compounded annual growth rate (CAGR) and balancing your portfolio (80% shares, 20% bonds, average 9% return = #goals) in your earning years. When you start planning early, you have decades to ride out periods of lower returns, and your overall CAGR expands every year.
Using this 80/20/9 formula, and estimating your costs of living during retirement (while adjusting for inflation) is a good blueprint for your retirement investing.
How you structure your plans is critical. Here’s how sequencing risk matters. Suppose you start retirement with $1 million invested. So does your neighbor Fred. Now suppose that as soon as you retire, inflation skyrockets and your investments take a huge hit—so much that your shares really lose value and aren’t providing the income streams you need. After a couple of years inflation eases somewhat, but your million-dollar portfolio’s value is down to $750,000, and your income has decreased dramatically, along with your standard of living.
During this same period, Fred’s investments stayed fairly level when inflation was high, so his buying power remained stable. Fifteen years later, a second inflation boom comes along, and this time, Fred’s investments take the fall. Yet, his overall portfolio is still over $1 million.
How did this happen? He was still getting a strong CAGR in the early years, when you got hammered. This set him up to ride out another run in high prices without a decrease in income.
You need professional advice in planning for inflation
The bottom line? No matter how successful you are in your career, you need a professional financial advisor to help you navigate retirement investing, and you need to trust this individual to make the right decisions based on your financial needs. Expert financial advisors see trends before you find out on the news, and can rebalance your holdings as needed—so that your emu-sized nest egg doesn’t shrink to a robin’s egg in one inflationary run.
Speaking with a financial advisor at Super Network will help you develop a plan for your retirement. For a free, no-obligation discussion on how to budget for your retirement, contact Super Network today.
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