Retirees worry more than most of us about inflation, although there hasn’t been much to worry about for several decades.
This year is different. Economic crises and the beginnings of a post-pandemic recovery have produced hot inflation figures. Many experts see the trend as temporary, but for now, financial advisers face an unknown landscape when it comes to clients and inflation.
Retirees are particularly sensitive to inflation because portfolio income does not have an inherent adjustment for inflation, unlike salary income, which tends to be adjusted to reflect the cost of living over time. . And retirees usually don’t add to their accounts, which makes portfolio returns especially important. In contrast, retirees benefit from one of the only inflation-covered assets we have: social security benefits.
Let’s review the current disarticulated landscape.
Investments and savings
Retiree surveys show that how inflation might erode the value of savings and investments is a major concern. And right now, your customers may be getting a whiplash after a decade of enjoying both low inflation and solid ROIs.
The options for adjusting portfolios to protect against inflation are limited.
Stocks are often mentioned as a way to track inflation, but they are not a hedge because stock returns are not correlated with inflation. That said, stocks can exceed inflation over time, depending on when they are sold.
The traditional argument of bonds still holds true: they serve as ballast for the portfolio. But it’s a painful argument now, with interest rates close to zero – negative after inflation, and perhaps even after deducting advisory fees if they’re billed on an asset-under-management basis. The annualized yield on Inflation-Protected Treasury Bonds (TIPS) is also negative right now.
The current environment suggests a cautious approach to portfolio cuts, especially in the early years of retirement. Christine Benz, director of personal finance at Morningstar, made this point in a podcast discussion with me earlier this year.
“If you are worried that your wallet is not making much money and at the same time you are worried that your withdrawals have to be increased to maintain your standard of living, it seems to me that you would like to start off pretty conservative,” she said. . “It’s a tough remedy, because 4% is not that much on most wallets, and you tell people to take less, it really starts to hurt their quality of life. “
Advisors should give clients a long-term perspective, argues Allan Roth, founder of Wealth logic. “In the early 1980s, I could get 12% on a high quality bond, but a third was eaten up by taxes and inflation, which was 13% or more. So I lost a lot more of my purchasing power than today.
At the Morningstar Investment Conference in September, panelists pitched ideas like natural resource stocks and commodities funds as attractive means of inflation-sheltered portfolios, but this type of active movement depends on the market timing that rarely works in the long run.
Roth notes that some advisers are tempted to turn to higher risk assets, such as junk bonds and alternatives. “The mistake that keeps coming back is the bad timing of the equity and fixed income market,” he says.
What are the reasonable responses to retirees’ concerns about the risk of inflation?
To get started, let customers know that there’s a good chance the recent trend in inflation is temporary. “The bond market says it doesn’t experience high inflation just like the stock market,” says Roth. “The market may be wrong, but I generally don’t bet against it. “
Social security strategies
And for clients who have yet to claim Social Security, give serious thought to claims strategies. An often overlooked aspect of Social Security’s value is the Annual Cost of Living Adjustment (COLA) it grants beneficiaries each year at no additional cost or risk.
COLAs are determined by an automatic formula linked to the Consumer Price Index for urban and office workers (CPI-W). COLA provides a powerful rationale for optimizing Social Security benefits through delayed claims and smart, coordinated filing strategies. Your client will receive approximately 8% more income for each 12 month period that she delays production after full retirement age. And, it should be noted that the annual COLA is applied to the amount of her future benefits, even if she has not yet applied, from the year she turns 62.
Early deposit reductions and deferred deposit credits are designed to be actuarially fair. That is, they offer the same benefit for life, depending on longevity expectations, no matter when you produce. But experts note that the underlying factors – which date back to the 1950s – have not been adjusted enough over the years to account for falling interest rates and increasing life expectancy. .
Longevity has increased most strongly among high earners, which means that deferred deposit is particularly beneficial for high income retirees and the reductions for early deposit are too large.
For clients registered with both Social Security and Medicare, note that the Part B premium is deducted from the Social Security benefit. In recent years, the increase in Part B has consumed some or all of the COLA. But the recent surge in inflation has led to a COLA historically high of 5.9% for 2022. This increase will give Social Security beneficiaries a substantial net increase after any increase in the standard Part B premium. This figure is usually released later in the fall, but the Medicare Trustee’s report, released in late August, predicted. a bonus of $ 158.50, an increase of 6.3% over this year.
The dollar amount of any Part B increase is deducted from the Social Security COLA dollar increase. This would leave most Social Security recipients with COLAs of five percent or more. If you have a client with a monthly benefit of $ 2,000, her monthly payment will increase by 5.5%, for example.
By most measures, COLA does not fully track inflation experienced by the elderly, especially rapidly escalating health care costs. But it is something.
Mark Miller is a journalist and author who writes on retirement and aging trends. He is a columnist for Reuters and also contributes to Morningstar and AARP magazine.