Honey, I Shrunk the Checkbook: What Inflation and High Prices Mean for Your Retirement
Inflation can be a puzzle for investors nearing or in retirement. Moving to a more conservative portfolio feels safer, but can it support the lifestyle you want as prices rise?
In 1989, Honey, I Shrunk the Kids introduced moviegoers to Wayne Szalinski, an absent-minded inventor whose experimental shrinking machine accidentally reduced his children to a fraction of their normal size.
More than three decades later, many Americans may feel as though someone has aimed a similar machine at their checkbooks. The culprit, of course, is inflation.
If you've bought groceries, paid an insurance bill, eaten at a restaurant, filled your gas tank or written a tuition check recently, you don't need an economist to tell you that things cost considerably more than they did five or six years ago.
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Consider what happened during and after the COVID-19 pandemic. Massive fiscal and monetary stimulus, supply-chain disruptions, labor shortages and pent-up consumer demand combined to create the highest inflation America had experienced in four decades.
For much of 2021, government and Federal Reserve officials characterized the surge in inflation as "transitory," expecting the rate of inflation to return toward normal relatively quickly. But by June 2022, the Consumer Price Index had risen 9.1% over the previous year.
While inflation has subsequently declined significantly, that doesn't mean prices have gone back to where they started.
Feeling the squeeze
Since early 2020, consumer prices have risen roughly 30%. That doesn't mean everything costs exactly 30% more. Some prices have risen much more, others less. But collectively, the purchasing power of a dollar has declined substantially.
On average, an item that cost $100 in early 2020 would cost roughly $130 today if its price rose in line with overall inflation. That helps explain why many Americans remain frustrated about the economy even though inflation has fallen dramatically from its 9.1% peak in June 2022.
The distinction between high inflation and high prices is important.
Inflation measures how quickly prices are rising. When inflation declines, prices generally don't return to where they were before. They simply rise more slowly. Think of a car traveling 90 miles per hour that slows to 30. It's still moving forward, just not nearly as fast.
Prices work much the same way.
And that means two things can be true at once: Inflation can improve significantly while consumers still feel squeezed by prices that remain substantially higher than they were several years ago.
Why even modest inflation hurts retirees
But for investors, particularly those approaching or living in retirement, there is an even more important lesson. Forget 9% inflation for a moment. Let's talk about 3%.
Three percent inflation doesn't sound particularly frightening. It certainly doesn't generate the headlines that 9% inflation does. But over a long retirement, seemingly modest inflation can quietly become one of the biggest threats to financial security.
Using the Rule of 72, an inflation rate of 3% would roughly double prices every 24 years. Imagine retiring at age 62 and living until age 86. That's 24 years. If inflation averaged 3% throughout your retirement, something costing $100 when you retired could cost roughly $200 near the end of your life.
Now apply that to a retirement lifestyle.
Suppose a newly retired couple needs $80,000 annually to maintain their lifestyle. At 3% inflation, maintaining approximately that same purchasing power 24 years later could require something approaching $160,000 annually.
No pandemic required. No 9% inflation. No oil shock. Just 3% inflation quietly compounding year after year.
That's why one of the biggest mistakes retirees can make is believing that retirement automatically means their investments should become extremely conservative.
Certainly, reducing investment risk as we age can make sense. Someone who is 70 probably shouldn't invest exactly as they did at 40. Retirement portfolios generally need appropriate reserves, income-producing investments and enough stability to help fund spending during difficult markets.
But becoming too conservative can introduce purchasing-power risk. A portfolio can appear safe on a statement while gradually losing its ability to support the lifestyle it was designed to fund.
I sometimes describe this as "going broke safely."
You can avoid much of the day-to-day volatility of the stock market by holding predominantly cash and conservative fixed-income investments. But if those assets fail to produce returns that keep pace with inflation, taxes and withdrawals over several decades, the apparent safety can become its own form of risk.
That's why retirement planning isn't simply about eliminating volatility. It is about balancing multiple risks. Market risk matters. So does inflation risk. Longevity risk matters too.
Today's retirees face an additional challenge because many may spend 20, 25 or even 30 years in retirement. A 30-year retirement isn't a short-term financial event. It is an investing lifetime of its own.
How to prepare
That means a well-designed retirement portfolio may still need meaningful exposure to growth investments, even after the paychecks stop. The appropriate balance will differ for every investor. Spending needs, Social Security, pensions, savings, taxes, risk tolerance, health and longevity expectations all matter. There is no single allocation that works for everyone.
But there is one principle that applies broadly: Retirement income should be planned in purchasing-power terms, not simply dollar terms. Receiving the same $80,000 of income 20 years from now may feel comforting on paper. But what matters is what those dollars will buy.
That may be the most important lesson from the inflation experience of the past several years. Nine percent inflation gets our attention because we can see and feel it immediately.
Three percent inflation is easier to ignore. But over a long retirement, 3% inflation quietly compounds.
And if your financial plan doesn't account for it, you may start looking around for Wayne Szalinski after discovering that someone, or something, has shrunk your checkbook.
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