When a prospective client over the age of 55 calls my office, more times than not, it is someone who is thinking about retirement. He or she has been working for many years, has accumulated some significant assets, may or may not be eligible for some type of pension and will have social security income. They want to know if they have enough to call it quits now or if they are on the right track for retirement in 5 or 10 years. They have run the numbers themselves and are fairly confident, but just want to double check with a professional to be sure.
And more times than not, there is one critical factor that is overlooked when calculating retirement, and that is inflation. Maybe it is overlooked because, lately, inflation has been relatively low from year to year at approximately 1%-3%. However, the effects of inflation are magnified when you consider the effects of compounding. Consider that in 1916, a quart of milk cost $0.09. Today $0.09 would buy you about 7 tablespoons of milk or reviewed another way, you would need $2.20 to buy that same quart of milk today. If you need $75,000 a year to live today, assuming a 2.5% inflation rate, you will need over $122,000 to maintain that same purchasing power twenty years from now! We know that today’s money will buy less tomorrow, but what does that mean for retirement?
Consider the following:
- Portfolio value today = $500,000
- Inflation rate = 2.5%
- Portfolio withdrawals = $20,000 to meet cash needs
This example is a bit simplified as the rate of return will not be constant from year to year, but it does illustrate the importance of having a growth component to your portfolio. Stocks are the best vehicle to obtain this long-term growth. By implementing a low-cost and well-diversified portfolio – one that encompasses US and international stocks, small and large company stocks, value and growth stocks – many of the risks associated with owning stocks can be mitigated. Additional components of the portfolio may include some shorter-term fixed-income investments to meet your short-term cash needs as well some inflation-protected securities.
Many retirees erroneously believe that it is most prudent to adjust one’s investment portfolio to one that is extremely conservative once they retire as they cannot risk losing any money. A portfolio that is too conservative will guarantee this loss. Alternatively, a properly structured portfolio that is designed to meet your cash needs for both the short and long-term can significantly increase the probability that you will have adequate retirement resources to support you for your lifetime.