5 causes of inflation—and how to protect your retirement savings against them

february 2, 2024


Inflation can fall especially hard on retirees. Learn what the top causes of inflation are, and how to protect your retirement savings from its effects.

We’re all thankful that inflation has mercifully retreated from its 40-year high of 9.1% in July 2022.1 But at 3.7% as of September 2023,2 it’s still 10 times higher than before the COVID pandemic.3

As inflation lingers, so do its consequences – including its effect on your retirement. What are the causes of inflation, and its effects, and what approach can you take to protect your retirement savings?

Inflation falls especially hard on retirees because, in addition to raising the cost of the things they buy today, it also reduces the value or purchasing power of dollars they may not spend for many years. If retirees haven’t factored the effects of inflation into their financial planning, or haven’t anticipated how high inflation will go, they could be forced to make painful changes to their retirement plans.
 

The top causes of inflation

Why do prices go up? Here are five factors to watch for:

  1. Increased demand raises prices, just as a bevy of bidders at an auction will bid up the price of a limited item. This is one of the most familiar causes of inflation. Essential items – food, clothing, shelter – are most susceptible to demand-pull inflation because they’re necessities that people can’t do without, so sellers know they can raise the price and pocket the increased profit.
  2. Increased costs of raw materials for manufacturers can also hike prices for consumers. When war, labor strikes, or government regulation makes the raw materials of manufacturing (including fuel) more costly, that increase often finds its way into consumer prices. Supply-chain disruptions, such as the ones that kept ships from delivering raw materials and components during the pandemic, are another factor.
  3. Increased labor costs. Wages, like raw materials, can increase a manufacturer’s or service provider’s costs and get reflected in higher prices for consumers. Labor costs can go up because of renegotiated union contracts, revised government regulations, or increasing competition for workers. Rising wages affect inflation in another way as well: When workers have more money, they spend more, bidding up the prices of consumer goods and services.
  4. Increased money supply. The government increases the supply of money in the economy when there’s a growing chance of a recession. More money means more spending and investment, and it can keep the economy from stumbling. But too much of an increase in the money supply can lead to too many dollars chasing too few goods, and more inflation.
  5. Self-fulfilling prophecy. When business, government, or labor leaders anticipate inflation, the steps they take to mitigate its impact can actually create or exacerbate inflation, turning their actions into a self-fulfilling prophecy. For example, when the government increases social transfer payments to help people afford rising prices, they increase the money supply, which can further drive up prices. Great idea, but maybe not a great approach.
     

Top ways to protect your retirement from the effects of inflation

Fortunately, you’re not forced to stand by and watch the effects of inflation reduce the buying power of your retirement savings. There are ways you can fight back. Here are five of them:

  1. Tighten your belt. We’re putting the painful one upfront. Times with a rising inflation rate may be a good time to reduce your discretionary spending. Anything you do to decrease your spending reduces the amount of money you have to take from retirement savings. And the less you withdraw, the more is left to generate interest and returns. Work with your financial professional to plan the withdrawal strategy that works best for you.
  2. Check investment fees. High fees are like a tax on your retirement savings, and nobody likes taxes. Fees associated with 401(k)s are typically lower than fees associated with mutual funds that comprise most IRAs. So, if you’ve been thinking of rolling over your company pension to an individual plan, think again or do some real comparison shopping before you make a rollover.
  3. Consider a reverse mortgage. Here’s a way to make inflation work in your favor. If real estate prices have increased because of inflation, there’s likely more equity in your home that you can tap into when you need it, either by selling and downsizing or by staying in place and taking out a reverse mortgage. There are pros and cons to a reverse mortgage, so talk this one over with your financial professional.
  4. Annuities may provide guaranteed income. That’s especially helpful when other income sources may be uncertain. You may even be able to buy an inflation rider. Although the rider will add to the overall cost of the annuity, this add-on benefit is designed to keep up with rising costs.
  5. Postpone Social Security to maximize your benefits. If you were planning to take Social Security at 62 or shortly thereafter, consider holding off until you reach, or get closer to age 70. Generally, the longer you can wait, the more you can see in that monthly check when you start receiving it.

Guarding your nest egg from the effects of inflation can be a challenge – but it is possible. As always, talk with your financial professional about the ways that are best for you.

 

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1. PBS News Hour, “U.S. inflation at 9.1 percent, a record high,” July 13, 2022, accessed October 25, 2023

2. YCharts, US Inflation Rate (I:USIR), accessed October 25, 2023

3. Steve Maas, NBER, “Inflation Measurement in the Era of COVID-19,” August 2020, accessed October 25, 2023

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