Inflation and Purchasing Power
Inflation is a common term in economics. However, many economists and policymakers over the course of the last few decades have lost sight of the problem inflation creates. Ask a professional how much inflation they think we have and you are likely to hear about the official rate, which is often about 2% per year.
Take a look around and then think about how much your money buys you. Housing, college tuition, and health care costs have all soared over the last decade. Food and gas prices have increased substantially in the last few years.
Moreover, you may have noticed that your pay has not outpaced these increases. It seems that everyone is paying for more things with smaller amounts of money. The reason for the discrepancy between the inflation rate and the actual value of your paycheck is the purchasing power of the dollar.
The purchasing power decreases once the government creates new dollars. Since our dollar is fiat currency, it can be created anytime the government wants. As a result, more dollars are spent and the value of the dollar declines.
How does the government create new dollars? The Federal Reserve creates and gives them to the government, or governments of foreign countries.
One of the factors that causes most inflation is government spending. The federal government has increased spending dramatically in the years since 2007. TARP, Obamacare, and Dodd-Frank have cost trillions of dollars of taxpayers’ money.
Social Security Cost of Living
For most seniors, Social Security provides a significant portion of their annual retirement budget. Keeping up with inflation is one of the most important ways to ensure that Social Security has the same value for you year after year.
By following a few simple steps, you can make sure that Social Security keeps up with the rise in inflation and that you’re aware of how inflation is affecting your benefits.
The Cost of Living Adjustment (COLA)
Social Security benefits are adjusted each year (as of this writing) to reflect inflation. The increase is known as the Cost of Living Adjustment (COLA) and it is applied to every SS benefit.
Along with the increase the Social Security Administration also publishes the percentage increase that they used to calculate the COLA. This increase reflects the increase in the Consumer Price Index (CPI) for Urban Wage Earners and Clerical Workers (CPI-W).
For more information on how COLAs are calculated, you can read this article.
How to Track Inflation & Use the CPI-w to Adjust Payments
The easiest way to track the changes in inflation is by subscribing to the CPI-W.
Steps You Can Take to Mitigate the Impact of Inflation in Retirement
As a general rule, it is important for individuals to plan for inflation when creating financial projections in retirement. Inflation is the average increase in the price of a basket of goods and services. Although inflation may mean higher prices, inflation also provides its beneficiaries with higher wages. Retirement is a period in which people experience a higher amount of longevity and lower rates of income. Along with the fact that a percentage of retirees are retired on fixed incomes, these individuals become targets of inflation. Although individuals significantly reduce their spending after retirement, the prices of goods and services still increase. This situation makes retirees vulnerable to inflation.
The great challenge that retirees who are not on a fixed income but rather from sources that are exposed to price inflation endure is the inability to adjust their expenditure patterns. The second problem faced is that inflation also reduces the purchasing power of the dollar, creating the impact of a downward spiral. It is not impossible to mitigate the impact of inflation in retirement. You may take these steps to prevent yourself from suffering the negative effects of inflation during this period in your life.
Retirees may consider using a percentage of their accumulated assets to purchase inflation-protected bonds or annuities. This can be done by giving the money to a financial professional who will be in charge of investing the money.
Interest rate fluctuations and inflation are considered to be two of the largest risk factors that affect investments. Both can be managed, but it’s important to understand why and how in order to make a positive difference.
Money in the form of cash would undoubtedly be the best way to deal with inflation. However, it can be managed effectively in any portfolio with traditional, short-term and medium-term bonds.
Interest Rate Fluctuations
In order to manage interest rate fluctuations, you need to understand how bonds work. A bond’s value is based on its maturity and its interest rate. The longer the maturity, the more interest the bond would yield, but at the expense of a greater risk of default.