(photo credit: Getty)
Getty
For Baby Boomers who remember the double-digit inflation that helped put Ronald Reagan in the White House, today’s comparatively subdued annual increases in the Consumer Price Index probably rank low among their retirement-related concerns. Rather than trying to restrain inflation, the Federal Reserve is now striving to boost it to 2% per annum. So far, the central bank’s efforts have been to no avail, prompting calls for a switch from the present “Let bygones be bygones” approach.
Under that policy, if the Fed fails to lower the real value of your savings by the targeted amount in any given year, the monetary chiefs just tut-tut about it and resolve to do better in the next 12 months. In contrast, the “makeup” approach now being discussed would require the Fed to offset one year’s inflationary shortfall by taking a bigger bite out of purchasing power the next. For example, if 2020’s target is 2% and the actual rate comes in at 1%, the 2021 target would be 3%.
Whether inflation runs 2% each year or averages 2% over several years, it still sounds low to Baby Boomers who struggled to keep up with 1% a month CPI increases early in their careers. Complacency about inflation, however, could wind up making your retirement considerably less comfortable than it could be. The cumulative impact of even modest inflation can be devastating over the course of your post-working years.
A Long Time to Erode
According to the Social Security Administration, the expected lifespan from age 65 is 84.0 years for men and 86.5 years for women. Society of Actuaries projections indicate a one-in-four probability that one partner in a marriage will live to age 98, or 33 years beyond the traditional retirement age.
Now consider how much purchasing power you would have lost if you had retired 20 years ago and invested your life savings in a pure fixed-income portfolio. Over that period, the Consumer Price Index rose at just a 2.14% compound annual rate. As the pie chart below shows, however, you would have lost over one-third of your purchasing power through inflation. I like to illustrate this point by saying that if you went to the golf course, you would be allowed to play only 11.8 holes.
The key to avoiding such a grim fate is to provide for growth in income as you move your investments into retirement mode. Use bonds and preferred securities to generate a robust yield, but supplement those holdings with instruments that give you regular pay raises to offset the expected loss of purchasing power. Dividend-growth stocks are one such vehicle.
To illustrate, consider the eight stocks in S&P’s Dividend Aristocrats list with the longest (56 years) record of consecutive dividend increases, as of the beginning of 2019. Over the last ten years, their dividends increased at an average annual compound rate of 6.76%. With the Consumer Price Index growing at only a 1.73% rate over the same period, those dividend-growth stocks would have gone a long way toward insulating a predominantly fixed-income portfolio from the ravages of inflation.
Currently, the indicated yields on these stocks average 2.73%. This means that allocating a portion of your portfolio to securities of this sort would not devastatingly dilute your portfolio-wide yield. To mitigate the dilution further, consider also buying other, higher-yielding instruments that provide both income and growth. These include real estate investment trusts and master limited partnerships.
The Bottom Line
The true test of a retirement portfolio is not how many dollars it generates the month after you stop collecting a salary. What really matters is your quality of life in your golden years. The financial aspect of a satisfying retirement will be a function of the amount of goods and services you can afford. Simply maximizing your yield with fixed-income investments is the wrong way to go about it. The right way is to build some income growth into your portfolio to protect against the theft of purchasing power that even historically low inflation can commit.
Martin Fridson is editor of Forbes/Fridson Income Securities Advisor.