Nothing to see: Making sense of the inflation spike
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If you’ve been watching the financial news over the past week, you will know that Australia’s inflation rates have now peaked to a 13-year high.
What does that mean for retirees, and should we be doing anything to protect the purchasing power of our nest eggs?
We meet again
We haven’t seen systemically high inflation rates in Australia since the 1970s and 1980s, when double digit rates were commonplace.
It’s been a while. So, what is inflation?
It is the number one long-term risk facing retirees. Inflation is the rise in the price of an item over time. As inflation increases, purchasing power reduces and we can’t buy as much with our income.
Inflation explains why you could buy a dozen eggs for about 80 cents in the mid 70s, but today you can pay up to $7.
For most of us retirement is long, and inflation is the number one cause of people running out of money in retirement.
But don’t worry yet
The latest inflation numbers from the Australian Bureau of Statistics (ABS) show the annualised inflation rate at 3.8%. That’s above the Reserve Bank of Australia’s (RBA’s) target range of 2 to 3% a year. Generally when inflation gets above this range, the RBA tries to cool the economy by increasing interest rates.
So, should we expect to see interest rates rising again?
No, that’s unlikely. The high inflation figures were always expected. They reflect more on what was happening 12 months ago than what is happening now. In response to the first wave of Covid, the government implemented relief measures such as discounted childcare. These are now being unwound.
In fact, when you take account of the unwinding of the stimulus measures, core inflation is just 1.6% pa.
We are unlikely to see interest rates increase until inflation is consistently being reported within the 2 to 3% range. According to the RBA, that’s unlikely to be until 2024.
Inflation-proof your portfolio
Investing for retirement is complex. We need to balance short-term risks, like share market crashes with long-term risks such as inflation.
At When Financial Solutions we apply a framework to balance these risks. We set aside the money you need today and the next few years and park it in cash, term deposits and other secure investments.
But cash and term deposits don’t protect against the long-term risk of inflation. Only growth-style investments, like shares and property, do that. So, with your short term needs safely provided for, we are free to invest the rest for the long-term. Sensible exposure to quality growth-style assets protect against inflation and provide a higher return than fixed interest investments over the long run.
So, it’s not a matter of ‘if’ you can have the confidence to spend in retirement, but ‘when’.
Michael Bowman and James McMaster are co-founders of When Financial Solutions. This article is general and does not consider your personal circumstances so it may not be appropriate to you. If you would like advice specific to you, please give us a call.