Inflation is back, and it can affect your retirement, even if it’s decades away. As the rate of inflation goes up, the purchasing power of the dollar goes down. From 2000 to 2020, the average inflation rate was 2.30%. That may not seem like a lot, but it means that what cost $100 in 2000 required $165 in 2020.1
Then in 2021, the Consumer Price Index jumped 7% and early 2022 numbers suggested this trend may continue for a while. As the chart below shows, extended periods of inflation can happen but are infrequent. Even so, some economists believe inflation will settle at 3% to 4% around the end of 2022 and remain at that level for decades.2
Sustained high inflation has been rare in U.S. history
Sustained periods of elevated inflation have been anomalous in U.S. history. According to data compiled by the Minneapolis Fed, in fact, customer prices have risen by at least 5.0 percent across two or more consecutive years only seven times since 1800, with most of these episodes coinciding with war or its immediate aftermath. Transitory inflation has been much more the norm than the exception.
Source: Federal Reserve Bank of Minneapolis
Avoid emotional responses to changing market conditions
A sudden spike in inflation can lead to periods of market volatility and negative returns. This often triggers an urge to flee from stock funds to “safer” investments such as stable income funds and other fixed income funds. But Inflation can quickly erode the value of cash positions and fixed income investments, such as bond funds, tend to underperform in periods of high inflation.
You need a strategy that earns return on an investment
Return on investment refers to the difference between the rate of return received from an investment portfolio and the rate of inflation. For example, if interest is 2% but inflation is 7%, the investor sustained a negative 5% return.
The good news is, since 1926 the S&P 500 has had an average annual return of 10.49%3 while U.S. inflation has averaged 3.25% annually.4 However, life rarely reflects averages and past performance cannot predict future results.
Considering that the average length of retirement is about 20 years, you should account for inflation in your retirement planning strategy, even if you are close to or already in retirement.