Return of inflation
Do you have enough to Retire?Free Retirement Plan Health Check
The news that inflation grew more than expected in the September quarter has spooked retirees and homebuyers equally. And rightly so; inflation is bad news for retirees who are trying to balance spending today, while being responsible for the future. And for homebuyers, the return of inflation may mean increasing interest rates and mortgage stress.
So, what has caused the inflation spike? And what will happen if prices continue to rise? More importantly, what can pre-retirees and retirees do now to protect themselves from inflation risk?
Inflation refers to the increase in prices over time. When prices rise, the purchasing power of money decreases, creating challenges for retirees who are no longer earning a salary.
Prices are rising globally. In Australia, underlying inflation increased 0.7% in the September quarter, which equates to 2.1% over the past 12 months. That’s within the Reserve Bank’s target range of 2 to 3% per annum.
It is possible that the increase in inflation is temporary. It has been caused by the complications in the global supply chain caused by lockdowns, and the pent-up consumer demand now that we’re re-emerging.
But it might be here to stay. And if it is, and underlying inflation continues to grow faster than 2% per annum, the Reserve Bank will likely increase interest rates.
Rising interest rates
The Reserve Bank has said it doesn’t expect to increase interest rates until 2024, but this may change things.
If interest rates are increased earlier than expected, then that can have a negative impact on asset prices. We can expect to see householders under mortgage stress, more sellers than buyers, and falling house prices. We may see share market falls as share prices reflect falling sentiment and lower profit growth outlooks for businesses.
Managing inflation risk
It may be tempting for retirees to invest more conservatively to protect themselves from market falls, especially since shares and real estate are at record highs.
But cashing out of shares and property is not a long-term answer, especially with interest rates at record lows. Shares and property behave as a hedge against inflation, with the potential for long-term capital growth.
Keep in mind, inflation risk is not the only risk facing retirees. They also need to manage longevity risk, market risk and sequencing risk. Longevity risk is the risk of running out of money, and market risk involves fluctuating asset values. Sequencing risk is the risk that the timing of investment loss is unfavourable, for example at the start of retirement.
It may seem an impossible challenge, but at When Financial Solutions we apply frameworks to help manage all of these risks for retirees.
We can provide you with spending confidence today, increase your sense of certainty in the short-term, as well as exposure to growth assets to provide protection against inflation. So, it’s not a matter of ‘if’ you will have peace of mind 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.