Inflation is one of the biggest risks when it comes to your retirement. Why is that? Because if inflation is too high (in proportion to your investment returns), then inflation will eat away at something called your purchasing power. So over time, your purchasing power will decrease, year over year, ever so slightly. But over time, and especially 2-3 decades, you will feel it in your budget.
In simple terms, the hundred dollars you own today has more worth than a hundred dollars to be received in five years. It’s because prices are expected to increase in five years, and you’ll be able to buy fewer items in the future with the same amount. Hence, your purchasing power decreases with time, which is the main attribute of inflation.
A couple of examples for us. If you wanted to retire 20 years ago, in 2001, let’s say you wanted to have $4,000/mo of living expenses. How much would you need today to purchase the same amount? It would be $6,169.56. So you can see, for a 20 year time horizon, the initial amount that you want to spend in retirement will have to have some adjustments for inflation in there.
In the last 12 months, however, the annual inflation rate of the country was 5.4% for the year ended July 2021. This has led a lot of people to think about potential reasons for higher inflation and its impact on individual consumers.
Today, I want to discuss: Why is inflation increasing right now?
Inflation is increasing in the country because of several factors that include reopening of the economy, increased labor cost, and higher Government spending. Now these are just three factors, and I’m sure there are other factors as well. But I felt like these three were important to highlight.
Reopening of the economy
The country is reopening, and people are excited to purchase the products they could not get in the lockdown and COVID restrictions. This led to increased expenditure in the economy and increased demand for products.
Just think about traveling and entertainment, which were basically banned during a pandemic and its reopening led to a sharp increase in demand. On the other hand, companies are still recovering from the unexpected collapse of demand in last year and finding it difficult to satisfy the current demands of their services and products.
This type of imbalance is one reason why inflation is higher than normal. It’s not expected to last as businesses and consumers get back in the flow of things, but it has been a reason why we’re seeing inflation at the current high levels we have right now.
Increase in labor cost
The rising rate of wages in the country has instigated the rate of inflation. In the last two months, there was a 7.4% increase in the labor wages rate which is three times more than the average increase. This increase in the rate of wages is a direct result of the increased demand for products in the market.
American manufacturers have been flooded with massive orders to produce different products, including appliances, cars, furniture, homes, etc. Still, they cannot meet the demand simply due to a shortage of labor.
There are lots of reasons for this, and I am certainly not an economist. That said it seems as if the shortage of labor can be associated with fear of the pandemic, very generous pandemic unemployment benefits, stimulus checks, and closure of schools and day centers. These issues are causing workers to stay at home instead of going back to work.
So these companies have to keep paying higher wages, and still often can’t get as many workers as they need. So they need to pass their higher labor costs to the consumer, leading to an increase in the rate of inflation.
Higher Government spending
When the Government spends a higher amount of money in the economy, there is an increase in aggregate demands of products, which eventually leads to an increase in the price of the products. The increase of demand is powered by the increased purchasing power of people as their disposable income increases.
And many people have more disposable income because of higher government spending throughout the pandemic.
Since March of 2020, “The federal government has enacted six pieces of legislation that provide relief to individuals and corporations that have been affected by the COVID-19 pandemic”, totalling about $5.3 trillion. And we already had around $23T in debt at the start of the pandemic.
There are also other bills in Congress right now that may or may not be passed, but that could ramp that number up even more.
Why does inflation matter?
Inflation not only impacts your list of grocery and life standards but retirement and financial planning related to your future. It can be one of the biggest hidden costs of your retirement, as inflation continues to go up and up each and every year.
When you have a properly structured portfolio, your investments are able to help you keep your living expenses matching, or exceeding, inflation.
So, there is a need to develop a portfolio with strong growth that covers inflationary effects along with your targeted cash flows. At my firm, we can help you develop an investment portfolio considering several factors, including inflation, growth potential, and diversification, that ensure your financial independence at retirement.
If you’d like to make sure you have the right investments to weather the inflation that is occuring now, you can get a free one page financial plan from me when you book a call at StartMyRetirement.US. Yes, if you make a call with me and I feel like we’re a good fit to work with each other, I’ll create a one page financial plan for you that shows you everything you need to do to prepare and succeed in retirement. Have a great week.