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May 2022 E-Newsletter: Beware the Money Illusion Thumbnail

May 2022 E-Newsletter: Beware the Money Illusion

Jonathan M. Gardey, MBA, CFA®, CFP®

President and Chief Executive Officer

We are experiencing an inflation surge unlike any we have seen in forty years.[1] It certainly must be a shock to the more than two-thirds of Americans who weren't around to experience the last inflationary period.  Everyone is feeling the pinch of higher food and gas prices. While higher prices now are a concern for many people, the erosion of purchasing power over time is the real threat, especially for those in or near retirement.

Beware the Money Illusion: How Inflation Can Lead to Skewed Retirement Numbers

The concern most people have about inflation is its impact on their pocketbook with the prospect of spending hundreds of dollars more on necessities today than they did a year ago. That spending is based on what economists call "nominal dollars," which is the money sitting in your checking account today. However, your purchasing power ten to twenty years from now is based on "real dollars," which is how your money is valued after accounting for the impact of inflation.[2]

In an inflationary environment, the value of money in the future is worth less than the current value of money. In other words, your money—dollar for dollar—will buy less in the future. This produces what economists refer to as the "money illusion.” The money illusion is the false belief that your money has a fixed value over time even as inflation is devaluing it.[3]

How Inflation Skews Your Retirement Planning

While dealing with how to make their nominal dollars go further today, most people don't consider the impact of inflation on their purchasing power in the future. Even with inflation averaging 3%—a little more than its average over the last ten years—you will lose half your purchasing power over the next 23 years (using the Rule of 72 to divide the number 72 by the inflation rate).[4]

In planning terms, if you plan to retire in 20 years with a target income of $60,000, you would need the equivalent of $108,000 in today's dollars. In other words, at 3% inflation, the $60,000 you have to spend in 20 years will be worth less than $34,000. Try out this inflation calculator to see for yourself.

Underestimating your needs in terms of today’s inflation rate then could then leave you in quite the predicament twenty, thirty, or forty years from now.

Inflation Reduces the Real Return on Savings and Investments

And it doesn’t stop at purchasing power, either. Inflation also reduces the real return on savings and investments. If you earn 10% percent on your investments and the inflation rate is 3%, your real return is only 7%. At the current inflation rate (7.9% as of February 2022), the real rate of return would be just over 2%. And if your returns are less than the inflation rate, you are actually losing money!

Steps to Take Now to Fortify Your Retirement Against Inflation

Needless to say, it’s crucial to factor inflation into your retirement plan. Considering the low rates earned on savings accounts and fixed yield investments, people near or in retirement are especially vulnerable to the dangerous effects of high inflation.

1. Recalibrate your retirement savings for inflation

The inflation rate is known to fluctuate. While it is high now, it may decline back towards its average of 2 to 3% [5] at some point. To plan conservatively and build a cushion, factor in an inflation rate of 4 to 6% over the next 10, 20, and 30 years. If, based on the current "real" rate of return you're earning on your retirement savings, you are coming up short, you may have to adjust your contributions (save more), your investment strategy (earn more), or your retirement target date. The longer you have before retirement, the more minor the adjustments you must make.

2. Reconsider fixed-income investments that aren't likely to keep pace with inflation

Although interest rates are expected to rise in the future, the rates on savings accounts and CDs aren't likely to increase enough to outpace inflation. Look at your portfolio to see where you can replace low-yielding vehicles with lower-risk investments that have the potential to generate inflation-beating returns.

3. Consider an investment strategy that can grow your assets in retirement

The average person must plan for lifetime income sufficiency for up to 30 years. That's a long time horizon for maintaining purchasing power. While it is prudent to take on less risk once you retire, it is also essential that you continue to grow your assets to ensure they can last for your lifetime. Having the proper asset allocation that meets your particular investment objectives is critical for combating the impact of inflation on your purchasing power throughout retirement.

Don’t Let Inflation Scare You Into Indecision

Whether you’re great with numbers or the idea of calculating anything makes you queasy, don’t ignore the impact inflation can have on your retirement needs. Inaction can lead to decades of underfunding and a less than desirable retirement outcome.

At Gardey Financial Advisors, we work with our clients to make sure their retirement income needs are calculated with inflation and other risks already factored into their numbers. This way, they don’t run the risk of outliving their assets or having to live a diminished lifestyle.  If you are in need of a financial ally we encourage you to visit our site, learn more about our services, and see if we could be a good match.  We best serve clients looking for exceptional client service, who value a long-term partnership, and have minimum of $500,000 in investable assets.

Important Disclosure Information

Gardey Financial Advisors Disclosures

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product including the investments and/or investment strategies recommended or undertaken by Gardey Financial Advisors (“Gardey”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Gardey. Please remember to contact Gardey if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.  To better understand the nature and scope of the advisory services and business practices of Gardey Financial Advisors Inc., please review our SEC Form ADV Part 2A and ADV Part 3 (Form CRS) available via the SEC's website @ www.adviserinfo.sec.gov. (Click on the link, select “Investment Advisor Firm,” and type in the firm name. Results will provide you both Part 1 and 2 of the Gardey Financial Advisors Form ADV.) Statistics from third-party sources are deemed to be accurate but have not been confirmed by Gardey Financial Advisors. By selecting the links identified in this newsletter, you may be redirected to third-party websites, not under the supervision of Gardey Financial Advisors, who may have different privacy policies.

This communication is for informational purposes only and does not purport to be a complete statement of all material facts related to any company, industry, or security mentioned.  The information provided, while not guaranteed as to accuracy or completeness, has been obtained from sources believed to be reliable.  The opinions expressed reflect our judgment now and are subject to change without notice and may or may not be updated.  Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance.  Readers who are not market professionals or institutional clients of Gardey Financial Advisors should seek the advice of their financial advisor before making any investment decisions based on this communication.  Our firm does not render legal, accounting or tax advice. Gardey Financial Advisors works closely with our client’s other professional advisors.  Readers who are not market professionals or institutional clients of Gardey Financial Advisors should seek the advice of their financial advisor, tax, or legal advisor before taking any action that may have tax consequences.

[1] https://www.investopedia.com/inflation-40-year-high-2022-jan-5218703 15 March 20222 

[2] https://www.investopedia.com/terms/m/money_illusion.asp 15 March 2022

[3] Ibid.

[4] https://www.investopedia.com/terms/r/ruleof72.asp 15 March 2022

[5] https://www.thebalance.com/u-s-inflation-rate-history-by-year-and-forecast-3306093 15 March 2022