Prices are going up. Consumer price inflation ballooned to 6.8% in November as massive increases in government debt and supply-chain issues over the last year were reflected. The Fed & Biden believe they can get back to a 2% annual average target, but clearly that’s going to take some doing.
Retirement plans are especially susceptible to rising prices as fixed investments, pensions, bonds, and social security don’t always keep up with inflation. When I retired almost ) years ago, I put in a 2.3% assumption, based on the long-term Fed Target of 2.3% and a JP Morgan report that I read.
I knew then that our inflation assumption has a huge impact on how long our nest egg lasts. With Friday’s inflation news, I decided I would model out a 1 percentage point inflation change to see just how ugly it looks.
Here’s the baseline scenario 2.3% …
Here’s the same portfolio at 3.3% …
Isn’t it shocking to see how different they are? A single percentage point doesn’t seem like a lot, but compounded year-after-year it makes a massive difference.
Now the hope is that most of our investments maintain their real rate of return above the rising rate of inflation. We have 5.0% capital gains and 2.5% dividend growth estimate built in our model for a 7.5% total annual return. If inflation is 1 point higher, we need our investments to be 8.5% going forward. I think some of our investments will keep up, but others won’t.
How much inflation risk is in your retirement plan?
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