Your retirement plan is designed to help you meet two important objectives — beating inflation and pursuing your retirement savings goals. The challenge is finding the right mix to strive for both.
Why Be Concerned With Inflation?
Technically defined, inflation is the rising cost of goods and services over time. Like termites invisibly gnawing at the foundation of a house, inflation slowly eats away at the value of a dollar over time.
Inflation can also impact the success of your retirement savings strategy. In order to accumulate enough money to provide income throughout your Golden Years, you will need to factor inflation into your strategy. That means your investments will have to earn returns that are higher than the inflation rate — but how?
Consider Your Asset Allocation Strategy
Asset allocation refers to how you divide your savings among the three main asset classes — stocks, bonds, and money market, instruments. An appropriate asset allocation can offer the potential to help you pursue enough growth in your savings to both outpace inflation and strive for your goals.*
Consider the case of two hypothetical savers, Ebenezer and June. They both set aside $5,000 per year for retirement. Ebenezer puts 100% of his contribution dollars into the most conservative investment option, a stable value investment. June is also a steady saver, but she invests some of her money in stock funds, with portions in bond and stable value investments. June recognizes that stocks offer the highest potential return, but they also carry a significant amount of risk. That’s why she chooses some bond and stable value investments — to help offset any short-term losses in stocks.
Ebenezer’s money earns about 5% per year, while June’s money earns an average of about 8% per year. If you assume that inflation averages 3% per year, who do you think will end up with more money in their account after 10 years? Obviously, it’s June. She ends up with the inflation-adjusted equivalent of $66,034, compared with $55,844 for Ebenezer.**
How Do You Choose the Right Mix?
Choosing the right mix of stocks, bonds, and stable value investments in your retirement plan should be based on your personal situation. You will need to consider your savings goal, time horizon, and risk tolerance carefully. For more information on developing an appropriate mix, consider talking to a financial advisor.
*Asset allocation cannot eliminate risk of fluctuating prices and uncertain returns, nor can this strategy ensure profit or guarantee against loss.
**Inflation-adjusted equivalent is the future value of the account, in today’s dollars. Note that while the historical inflation rate has averaged around 3%, dramatic fluctuations have not been uncommon.
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