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Sequence of inflation

July 1, 2013

Most experts and analysts agree that we are likely approaching a new period of inflationary growth. One of the problems with this as it relates to retirement savings is that people frequently use a 3% rate of inflation to calculate their long-term retirement strategies. The reality is that, historically speaking, this is very low. In fact, in the past, inflation has only been 3% or less 52% of the time! But it isn’t just the raw rate of inflation that impacts retirement planning: the sequence of inflation (the order in which pattern/rate changes occur) is also critically important.

The reason that sequence of inflation is so important is that higher-than-anticipated rates early on in your retirement can have a disproportionately large impact on your savings—and subsequently reduce the window of time before you run out of funds. In fact, you don’t even need an especially long period of high inflation to make a difference: a higher-than-normal rate for just three or four years can make you run out of money a full decade earlier than planned.

The reality is that when rising inflation forces a retiree to withdraw more and more money just to maintain his or her purchasing power, depleting your money prematurely is almost inevitable. And that is why this is such a difficult problem to tackle: there really isn’t a great solution. There certainly isn’t an easy solution.

One possibility is to consider annuities if you are worried about running out of principal, but the best advice I can give to anyone planning their financial future is simply to be aware and to educate yourself: always take inflationary considerations into account. Do not rely on best-case scenarios when planning your retirement. I remind my clients all the time of the importance of not just preparing, but overpreparing for any eventuality.

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This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice. Please consult with a professional specializing in these areas regarding the applicability of this information to your situation.

Andrew Wood, Dan Simon and Alison Slezak are Investment Advisor Representatives. Advisory services are offered through CoreCap Advisors, LLC., a Registered Investment Advisor. CoreCap Advisors, LLC and Daniel A. White & Associates, LLC are separate & unaffiliated entities. 

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