Inflation is a big topic in today’s economic climate. Most people see it when they are grocery shopping or looking to buy a vehicle. But there are other ways that inflation affects your wallet. And that is in your retirement savings. So here is how inflation affects your retirement accounts.
What is Inflation?
Before we get too deep in the weeds, let me first remind you of what inflation is.
Simply put, inflation is the cost of goods and services going up over time. Think about it like this. A Big Mac at McDonalds would cost you $2.39 in 2002. In 2023, however, it will cost you about $4.95. That is inflation.
The cost has gone up over time for a particular product.
Some amount of inflation is actually a good thing for an economy. After all, you want to get cost of living raises each year right? You want the value of the stocks that you own to go up also. And you want to earn interest on your savings account. Some of that increase in value is due to inflation.
However, as we all have seen at the grocery store, the gas station, and pretty much anywhere else we shop, inflation has become quite painful for the regular person.
I won’t get too deep into it, but there are five main causes of inflation.
- Demand-pull
- Cost-Push
- Increased Money Supply
- Devaluation
- Rising Wages
There are certainly offshoots of each of these causes, but these are the five main causes of inflation. If you want a deeper dive into them, check out this article.
How Inflation Affects Your Retirement Accounts
As I said before, some amount of inflation is good for an economy. But too much can spell trouble.
We see it at the grocery store all the time. But we don’t tend to see it in our investments as much.
That is if there is one important caveat that is made.
That is if your retirement accounts are invested in traditional stocks, bonds, mutual funds, and ETFs.
Products like these are typically what your retirement accounts will be invested in. There might be some precious metals, currencies, or commodities sprinkled in as well. But the bulk of the investing weight is going to come from traditional investments as listed above.
When you (or your retirement account) buys an investment in stocks, bonds, mutual funds, and ETFs, you buy at a particular price. The price that you buy at is the “perceived” price in the market that takes into account likely future investment scenarios such as inflation.
So you might think, “I don’t want to invest in my retirement account right now because inflation is just eating it away.” But you would be wrong. The price that you purchase an investment in has already accounted for the potential (or maybe even likelihood) of inflation.
This is called Precision Pricing.
The idea is this: You thought of inflation before you purchased that investment, right? Yes.
So did a million other people. They purchased that particular investment at a somewhat-higher price to account for inflation. So when you buy it, the stock price has already accounted for inflation.
This could easily get into the psychology of the investor college class, and I don’t want to get that in depth for now.
The thing you have to remember is that inflation is already accounted for in the price that you paid for that investment.
That is if you left it in traditional stocks, bonds, mutual funds, and ETFs.
But what if you moved your investments into cash because you were afraid of the market?
How does inflation affect your retirement accounts if they are in cash?
Well then you have made a bad decision. Not one that can’t be undone at all though!
If you move your retirement accounts into cash, then inflation will simply eat them away over time.
For example, if you have $1 million in retirement now you would be able to buy $1 million worth of goods and services with that money.
But if we assume a 3% inflation rate and you wait 20 years to spend that money it would be worth only about $543,000 in today’s dollars.
So whatever you do, don’t pull your retirement money out and put it in cash. You saved that money for retirement, make sure that you use it for that same purpose. 🙂
Final Thoughts
So here is the deal. Inflation can be deadly to your retirement accounts IF you were to pull the money out and put it into cash. But if you leave it in quality investments, then you don’t have to worry about inflation much. The market has already priced it in.
You can do this!
I am here for you!
Until next time!
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