While much has been made over the notably low inflation levels in recent years, retirees aren’t having the same positive experience as wage earners. It’s true that inflation has remained persistently low, but even price increases of 1% per year can erode a retirement nest egg over time.¹ In addition, the areas where retirees spend most—health care and housing—are growing at rates much higher than inflation, leaving older investors in need of investment options that maximize earnings while limiting risk.

The takeaway for pre-retirees and retirees is that inflation remains an important consideration in projecting future expenses and income needs.

The 2% Threshold

Traditionally, the Federal Reserve System, the nation’s central bank, has tried to keep annual inflation growth close to, but below 2%.² The reasoning is that moderately rising prices give companies more revenue to raise salaries or make growth investments without making purchases unaffordable for consumers. The average annual rate of inflation, as measured between January and April 2019, has been only 1.75% since the onset of the last economic downturn in January 2019,³ spurring concerns that low inflation is now the new normal. Some economists attribute the change to technology advances that have made goods cheaper to produce. Others counter that innovation has increased demand for some products.

A strong U.S. dollar may also be a contributing factor. It makes American goods more expensive overseas and therefore creates pressure to keep prices low. Globalization and low-cost overseas labor markets may also be offsetting the nascent U.S. wage growth that’s being driven by a tight labor market.

The Federal Reserve Board (FED) is said to be considering changing the 2% target and allowing more inflation. The move would allow the Fed to offset inflation shortfalls and provide more room to lower interest rates in the event of an economic slowdown or recession.⁴ Of course, increased inflation across the board is bad news for retirees.

Low Inflation for Workers—But Not Retirees

But people in retirement are already feeling the pinch of fast-rising prices. Chronically low inflation has led to anemic Social Security cost of living adjustments (COLA).⁵ The current index used to determine these increases—the CPI-W—is based on average costs incurred by urban wage earners.

However, this benchmark doesn’t represent most retirees’ spending. Their two biggest expenses—housing and health care—have been ballooning in price for years. Housing prices rose at double the rate of inflation over the past five years, according to a Reuters report.⁶ Between 2012 and 2016, health care costs grew at three times the rate of inflation, according to a report in Modern Healthcare.⁷ COLA adjustments just haven’t kept up with these fast-rising price levels.

Low inflation also dampens earning power, especially in low-risk investments like bonds, often favored by retirees. This may encourage retirees to take on more risk in search of greater returns to keep up with their spending needs, creating portfolios with improper asset allocation and higher risk thresholds.

Hedging Against Inflation’s Risks

A diversified, well-allocated portfolio is the best hedge against inflation’s risks. Vehicles to consider may include:

Equity-based mutual funds: Equity markets, which typically outpace inflation, are popular during most inflation environments. Investing in well-managed funds with strong performance histories can be a good way to help hedge against inflation. However, it is important to note that equities are subject to market risk and a strong performance history does not guarantee strong performance in the future.

Global commodities: As inflation rises, the value of these funds typically does, too. David Whitten, Janus Henderson’s Co-Head of Global Natural Resources, says weaker commodity prices between 2011 and 2016 made natural resource companies more efficient and, ultimately, more profitable.⁸ Investing in commodities funds could give you growth in a rising inflation environment, but these investments may not be suitable for all investors as they can experience greater volatility.

Real estate: Real estate investment trusts (REITs), especially those that invest internationally, can provide the advantages of investing in real estate without the individual risk or capital commitment. Keep an eye on market projections, however, and ensure that the investment aligns with your risk tolerance.

TIPS: Treasury inflation-protected securities (TIPS) are U.S. Treasury bonds that are indexed to inflation. They have the backing of the U.S. government, and the bond’s value adjusts with the inflation rate. However, because of their inflation adjustment feature, inflation-linked bonds typically have lower yields than conventional fixed-rate bonds and normally decline in price when real interest rates rise.

Any investment strategy should be risk-adjusted based on your tolerance and how close you are to retirement. It’s also a good idea to consult a tax advisor to determine how various investments will affect your financial situation.

1. “How Inflation Eats Away at Your Retirement Income,” by Rebecca Lake, Investopedia, May 26, 2016,
   Retrieved from: https://www.investopedia.com/articles/retirement/052616/how-inflation-eats-away-your-retirement.asp
2. “Why Is Inflation So Low?” by J. Sánchez et al. Federal Reserve of St. Louis, 2018. Retrieved from: https://www.stlouisfed.org/publications/regional-economist/first-quarter-2018/why-inflation-so-low
3. “US Historical Inflation Rates: 1914 – 2019,” USInflationCalculator.com. Retrieved from: https://www.usinflationcalculator.com/inflation/historical-inflation-rates/
4. “The Fed Could Change How It Looks at Inflation and That Matters for Markets,” Alexandra Scaggs, Barrons, Updated February 28, 2019. Retrieved from: https://www.barrons.com/articles/fed-rates-policy-inflation-51551375474
5. “Improved Social Security COLA Would Help Seniors Stay Ahead of Inflation,” by M. Richtman. Reuters. February 28, 2019. Retrieved from: https://www.marketwatch.com/story/improved-social-security-cola-would-help-seniors-stay-ahead-of-inflation-2019-02-28
6. “U.S. 2019 Housing Market Outlook On Shaky Ground: Reuters Poll,” by H. Kishan et al. Reuters, November 29, 2018. Retrieved from: https://www.reuters.com/article/us-usa-property-poll/us-2019-housing-market-outlook-on-shaky-ground-reuters-poll-idUSKCN1NZ00K
7. “Healthcare Price Growth Significantly Outpaces Inflation,” by A. Kacik. Modern Healthcare, October 25, 2018. Retrieved from: https://www.modernhealthcare.com/article/20181025/NEWS/181029946/healthcare-price-growth-significantly-outpaces-inflation
8. “Global Natural Resources: The Silver Lining of a Downturn,” by D. Whitten. Janus Henderson, December 19, 2018. Retrieved from: https://www.janushenderson.com/aupi/post/19000/global-natural-resources-the-silver-lining-of-a-downturn