What does inflation mean for your retirement savings?

Rising prices constitute a concerning development for retirement nest eggs.

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Inflation has reached levels not seen in decades, showing up in the prices paid at the gas pump, at the grocery store register, and elsewhere. Savers increasingly question whether the higher future cost of living will mean that their current savings won’t go far enough, even if they grow in the meantime via a portfolio of investments.

Below, we address these developments and suggest ways to think about what inflation can mean for retirement.

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Keep things in perspective: today’s high inflation likely won’t last forever

It makes sense to be concerned about inflation, but we caution against panicking and potentially taking risks in the face of the recent increase in prices. Inflation, though it has been low over the past decade (often dipping below 2% on an annual basis), has had a consistent presence for much of the history of the US economy. The alternative of stagnant or even falling prices can throw a wrench into economic activity, depressing incomes, employment, and the value of investments.

We also don’t think that this bout of high inflation will ultimately last as long or be as dire as historical periods such as the 1970s in the US, when a wage-price spiral and commodity price shocks caused volatile inflation that contributed to a long-lasting economic malaise. The current inflationary environment appears to be driven by supply chain issues associated with operating an economy during a pandemic, though commodities have also been a major factor. This can be seen in the out-sized contribution of goods prices to the levels of inflation we see. We would expect goods prices to return to their longer-term trend of more modest contributions to price increases after the market takes its time to work out kinks in supply chains.

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Source: BLS, FRED. Core goods represent goods prices excluding food and energy. Core services prices represent service prices excluding food and energy.

Should I be concerned if I’m not retiring yet?

The short answer is that you should not be overly concerned. A major goal of any portfolio invested for the long-term should be the preservation of purchasing power, which can be eroded by inflation. The following are some of the ways that Betterment attempts to help you navigate through this environment.

1. Maintaining a well diversified portfolio.

Within the Betterment investing experience you have the ability to incorporate your risk tolerance (your ability and willingness to take risk), and time horizon (years left before you need your savings). If you’ve indicated that you are saving for retirement and you have a longer time horizon, we will recommend a Betterment Core portfolio allocation that has more stocks than bonds since you are able to take on more risk for the potential to generate greater growth compared to someone who is nearing or in retirement. Having a higher allocation to stocks not only helps serve this purpose, but inflation also flows through to company earnings and ultimately to the valuation of the stock market. During these earlier stages when the focus is on accumulation, we will also recommend asset classes that have historically seen higher growth, such as emerging markets, within stocks.

In the case of inflation surprising to the upside, there is an increased likelihood that monetary policymakers including the Federal Reserve in the U.S., may take steps to raise interest rates in the economy in order to dampen borrowing and inflationary pressures. This rise in interest rates can adversely affect the returns of bonds.

The recommended bond allocations in the Core portfolio strategy, however, are well diversified across geographies and credit quality. They have sources of return outside of markets which may face higher inflation than others. For example, most of the portfolios in the Core strategy hold an allocation to Treasury Inflation Protected Securities (TIPS), where the amount of the allocation varies according to the stock/bond split and overall risk level of the portfolio. TIPS are “inflation protected” in that the securities’ principal will be adjusted higher based on the increase in a consumer price index and the interest paid will be based on the inflation adjusted principal, shielding the return on the bonds from declining in real (inflation-adjusted) terms. Where and how you stay invested over time is important.

2. Inflation assumptions built into our advice

It is better to overshoot than undershoot your retirement savings. Building in inflation assumptions can help paint a better picture in estimating your future spending power. The advice we provide in our goal forecaster takes into account 2% annual inflation, and the projected retirement balances are adjusted after inflation. We regularly review this inflation assumption, and Betterment users have the ability to override it with their own expectation of annual inflation if desired.

Our advice tool highlights if you’re on or off track and whether there is a risk of shortfall from meeting retirement goals. It then provides guidance on how much you should be contributing in order to meet these goals. Something to note is that within this guidance, we will reflect any regulation changes that allow for greater retirement contributions. In 2022, the IRS is increasing the employee contribution limit for 401(k) plans from $19,500 to $20,500.

What if I’m nearing or in retirement?

Don’t worry, there are ways that you can bolster your retirement savings in this environment.

  1. Increase contributions: Those who are 50 years or older have the ability to make “catch-up” contributions of $6,500 on top of the $20,500, allowing a total of $27,000 in retirement contributions. This is a great opportunity for those nearing retirement who are concerned about their future retirement spending to contribute more. Additionally, Social Security general benefits increase based on cost-of-living adjustments over time.
  2. Hold off on taking required minimum distributions (RMDs): The 2019 Secure Act increased the age for when you would need to take RMDs from 70 ½ to 72. However, if you are 72 and meet certain requirements you do not need to take the RMDs right away, allowing your retirement savings to continue growing in the market.
  3. Maintain an appropriate level of investment risk: If you choose to follow Betterment’s advice, Betterment can automatically adjust your allocation through time to control risk based on your time horizon. Also, although Betterment’s qualified default investment alternative (QDIA) is the Core portfolio strategy, we have other investment options that are built for more conservative investing. Betterment offers the BlackRock Target Income portfolio strategy for those who may prefer not to be exposed to the risk of stocks. It is an all bond portfolio meant for generating income while preserving capital. This portfolio has four different risk levels which are associated with different income yield targets to help you generate a desired level of income.

Retirement is a long-term goal. Betterment will continuously guide you throughout different market environments and provide solutions to help you accomplish this goal.