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Accounting for inflation in your retirement plan

Accounting for inflation in your retirement plan

These days, as the economy lifts toward recovery, inflation isn’t a big deal – but, according to some experts, it could be. For retirees that could mean a big drop in the real future purchasing power of their investments.  Simply put, inflation means that the income you expect from your investments over the next 10, 20, 30 or even 40 years may be lower than in today’s dollars.

 

Over the last 20 years, inflation has averaged 2% a year but many financial advisors are planning for an annual rate of 4%. As a retired investor, this means that your portfolio will need to achieve an average return of at least 4% just to stay even. If that isn’t the case, you will need to go looking for higher returns or accept a more limited lifestyle. And with longer lives being projected for today’s retirees, you may need to stretch your retirement dollars over many more years – for example, financial advisors are now recommending that investment portfolios should be structured to provide an income until at least age 95.

 

Very conservative investors may find it challenging to achieve an average return of 4% or above – especially if they confine themselves to such fixed-income investments as Guaranteed Investment Certificates (GICs) or Government Bonds.

 

The income you will require for all your retirement years depends on your personal lifestyle choices and other factors – such as, whether you plan to travel extensively or are more of a ‘stay-at-home’ person – but most experts agree that protection against inflation means structuring a balanced portfolio that includes equities, along with fixed-income investments and cash.

 

A five-year study of the S&P/TSX composite index shows why: The period from 1976 to 1980 had an inflation rate averaging 8.9% per year but the 5 year annualized rate of return on the index was 26.6% and its real rate of return was 14.4%. If you had invested $100,000 in the Canadian index for that total period, it would have grown to just over $300,000 or $196,000 in real dollars – much better than the rate of inflation.

 

To assess your need for inflation protection, start with these questions:

? Which sources of your income are indexed for inflation – for example, your company pension?

? Which expenses will decrease over time – for example, travel expenses?

? Which expenses will increase over time and are likely to experience high inflation – for example, medical expenses?

? Which expenses will experience lower inflation – for example, utilities?

? To what degree do your current investments offer inflation protection?

 

You need a long-term strategic retirement income plan and I can help you develop – and monitor -- the right plan for you that takes into account the effects of inflation.

 

About the author

Pl. Fin. Noël Hémond

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