Is Inflation Really a Big Retirement Threat?

I’ve personal written on inflation before and how the Consumer Price Index (CPI) may be very far off from your own personal inflation rate.  Yet people still worry about inflation eating up your buying power in retirement, so I decided to look into it a bit.

I have a 2007 Andex chart which is basically a PF geeks pride and glory.  There is so much data in one chart it’s almost insane.  What’s interesting on the chart is it shows the CPI and some sample portfolios and provides compound returns for the last 30 years.  So from 1977 to 2007 the CPI averaged at 4.1% and that time period included part of the 70’s and all of the 80’s which were high inflation years.  Now then there are three sample portfolios called Aggressive (80% equity, 20 % Bonds and Fixed Income), Moderate ( 60% equity, 40 % Bonds and Fixed Income) and Conservative (20% equity, 80 % Bonds and Fixed Income).  It was assumed they were rebalanced at the start of each year.

The rates of return (ignoring taxes and fees) were:

  • Aggressive: 12.9%
  • Moderate: 12.1%
  • Conservative: 10.8%

So even adjusting those for the 4.1% CPI and fees you would still be fine with 80% in bonds and fixed income.  Actually it is interesting to note that despite the increased risks that Aggressive doesn’t do that much better than the Conservative.

In general I feel most people under estimate how important it is to protect your portfolio’s capital in retirement and over estimate the inflation threat.  As such they end up with more risk in their portfolio than they really need.  Now obviously you need some equity exposure as an all bond portfolio might very well not cut it (for example 90 day Treasury Bills only did 7.7% over that time frame).  So that is why I’m thinking about having about 70 to 80% of my retirement funds in bonds and fixed income.

That’s not to say I’ve firmly made up my mind yet, but I have yet to see an good evidence that I should have more than 30% of my portfolio in equities when I’m retired.

9 thoughts on “Is Inflation Really a Big Retirement Threat?”

  1. Tim, I have a book review of “The New Retirement” by Sherry Cooper (BMO chief econommist) coming up that mentions if you want your retirement dollars to last in the long run (30 years), you should have a 50/50 stock/bond allocation. That is, based on her equity growth assumptions. I believe her equity growth assumption is conservative ~4-5% after inflation and following the 4% withdrawal rule.

  2. I think a 1/3 stock, 2/3 bond allocation is reasonable for retirement income. You can work it out as follows: say you reinvest bond principal and live on bond interest, inflation is 3%, and stocks grow 10%. Then if 33% of your portfolio grows 10%, the whole thing has grown 3.3%, which lets you buy more bonds and grow the interest payments at pace with inflation.

    So this all works provided you can live on the interest payments from the 2/3 of your portfolio that’s bonds. That probably supports a draw rate lower than 4%, maybe more like 3-3.5%. @Million Dollar is probably right that an indefinite 4% draw probably calls for something more like 50/50.

    Your draw rate is an important consideration that should be factored in. If your portfolio is large enough you can afford the luxury of investing conservatively. Billionaires can live fine on the interest from a 100% muni bond portfolio.

  3. One other point, ‘old fashioned’ income funds such as Vanguard’s Wellesley Income, LifesStrategy Income, and Target Retirement Income have stock allocations in the 20%-33% range. So you are in good company.

  4. FT,

    Yep I read the book. I’m not saying her math is wrong, I’m just saying I don’t believe the CPI is my personal inflation rate. So hence the calculation is wrong for my application and hence my point I don’t think taking on extra risk is really that useful.

    In addition, I can’t believe anything an economist says regarding future market performance. 2008 managed to prove just about everyone of them wrong.


    Excellent point. A larger pool of cash can afford a lower rate of return and use a lower draw down rate. Both of which help a lot to avoid risk.

    Thanks for the mention of a few funds with a similar breakdown. My pension plan has a similar breakdown as well which I’ll likely use when I pull the plug.

    Thanks for the debate guys!


  5. Julie,

    Ah yes, inflation linked bonds. The trick is to make sure you are getting a good rate. Sometimes the return on the non CPI linked part can suck so bad you are better off with normal long term bonds.

    Otherwise it is worth considering.


  6. One point to consider is that one inflation rate that we MUST consider as “seniors to be” is (I am not exactly sure of the term they use) the rate of “health cost” inflation. We also have to consider that certain parts of this “inflation” may not yet lend themselves to numbers. Remember that we are going to lose about 40% of our Doctors and 40% of our nurses to retirement over the next 20-odd years + we will be losing full-time tax payors at just about the same rate. Also remember the “hit” on our economy already caused – and to RAPIDLY GROW – by the demand for elder care. Women ALREADY spend more time caring for parents and spouses than they do for kids – and that is going to grow. The biggest threat to everything women have accomplished in the last 60 years is the coming elder boom

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