How to deal with inflation risk in retirement

BOSTON (MarketWatch) — In 1960, the median value of a home in the U.S. was $11,900. Today, some 50 years later, you’d be hard pressed to buy a decent car for that amount given that the average price in 2010 was close to $30,000. And in 50 more years, you might find it impossible to buy a car for $170,000, which was the median sales price of a single-family home in the U.S. in 2010.

And that, my friends, is inflation — one of the most insidious risks Americans will face in retirement. Yet despite years of witnessing firsthand the insidious effects of inflation, many Americans are not taking into account the adverse effects inflation can have on their retirement plans.

Compared to other planning activities, only 72% of pre-retirees and 55% of retirees are calculating the effects of inflation on their retirement planning. And this highlights the need for individuals to better understand and manage inflation and longevity risks when planning for retirement.

Individuals always need to take inflation into consideration and now is the time to take action to address these inflation and longevity concerns by planning for multiple scenarios.

When it comes to inflation risk, every retiree should, for example, understand the basic fact that if annual inflation is 3% on average, in just 10 years a retiree will need to withdraw 30% more money, or more than $13, from their nest egg to purchase the same goods and services that cost $10 today. And much more disturbing, in 20 years that retiree will need to withdraw 80% more, or $18 to maintain today’s lifestyle.

One of the best ways to address the risk of inflation is to delay your Social Security, if possible, till age 70. Doing so, experts suggest, will give you the highest possible, inflation-adjusted, guaranteed stream of income possible from Social Security. Depending on your age, you could increase your annual benefit up to 8% percent per.

Investing in common stocks is certainly among the way to address the risk of inflation. Common stocks have outperformed inflation in the long run. There’s even one school of that suggests that retirees invest in the common stocks of those companies that represent the expenditures they have in retirement, such as health care, transportation, utilities and the like. That way, their portfolio will — at least according to the theory — grow in line the rising cost of expenses in retirement.

Still investing in commons stocks is not without its own risks. Such assets are poor short-term hedges against inflation. What’s more, investing in common stocks means that you sometimes trade inflation risk for investment risk. The historically higher returns from stocks are not guaranteed and may vary greatly during retirement years

http://www.marketwatch.com/story/how-to-deal-with-inflation-risk-in-retirement-2011-03-07?pagenumber=1