Can Your Nest Egg Survive Rising Costs? Ask Yourself These 3 Questions to Find Out
Inflation doesn't have to derail your future. Run your retirement plan through these three questions to see if your savings are truly protected.
From gas to food, prices continue to rise, highlighting the need for retirees to prepare for fluctuating expenses in retirement. After all, inflation was around 8% not long ago.
Sure, your Social Security benefits will keep up with inflation, but your retirement savings, pension, and other income won't, which can significantly affect your retirement lifestyle.
"Inflation is something that is constantly changing," said Chandler Riggs, CFP, VP and financial consultant at Fidelity Investments. As a result, she notes, "it should be a concern to retirees."
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At the last check, inflation stood at 3.4% in August, and while the Federal Reserve just raised interest rates to try to tame it, it's not clear when it will come back down. As a result, making sure your retirement savings are inflation-proof should be a top priority.
To ensure you're on the right track, ask yourself these three questions.
1. Is there enough growth in my portfolio?
During our working years, we focus on amassing a retirement nest egg and growing our portfolio, which often means taking on risk. But when we shift into retirement, preservation kicks in, and many of us become conservative.
However, being too conservative can backfire if our risk-averse nature results in an investment portfolio that doesn't keep up with inflation. That's why Riggs says the first question you need to ask yourself is: Is there enough growth in my portfolio?
"Inflation doesn't destroy a portfolio overnight; it erodes it slowly," says Riggs. Without enough growth, your purchasing power could diminish over a 20- or 30-year retirement, making the risk of outlasting your savings real, she said.
How conservative is too conservative depends on your savings, withdrawal plan, the lifestyle you envision, and your income sources. If you have enough income to leave your investments alone for several years, you can be more aggressive than if you need your money right away.
Riggs says some people set aside money in an easily accessible "inflation bucket" outside their growth, and an emergency bucket to cover extra costs in retirement.
That will prevent sequence of returns risk, which occurs when you are forced to sell stocks in a down market early in your retirement to cover expenses. These badly timed withdrawals can be a permanent drain on your nest egg, making it difficult for your portfolio to fully recover when the market turns around. "Having an inflation strategy is really important," Riggs said.
2. Can my spending withdrawal strategy keep up with inflation?
Saving is part of retirement planning, but so is determining how you'll withdraw the money once you retire.
If you draw down too much too quickly and inflation rises, you could run out of money. That's why Annette Anderson, senior wealth consultant at Charles Schwab, says the second question you need to ask yourself is: Can my withdrawal strategy sustain an increase in inflation?
Anderson says retirees must test their withdrawal strategy under different circumstances to see whether their money will last twenty or thirty years. Start with 4%, the traditional rule of thumb, then see what happens if you are forced to withdraw 5%, 6%, 7% or 8% a year due to rising costs.
Will your money last for three decades in those environments? If you can answer yes, you should be fine. If not, you may have to adjust your portfolio's risk or find areas in your budget where you can trim your expenses.
"If inflation does impact it, it's not a successful plan," says Anderson. "One has to make an adjustment somewhere in the savings or spending."
3. Is my retirement plan adaptable?
Inflation is a big question mark in retirement planning. It's one of the things that can throw your plan off course, especially if it jumps 8% as it did in 2022. That's why Riggs says the third question you need to ask yourself is: Is my retirement plan adaptable?
"Most inflation-resistant plans aren't rigid," said Riggs. "They are built to adjust as spending changes, as the market changes, as prices change and as life changes."
Just as the active "go-go" years of retirement require different spending than the later "slow-go" years, inflation could force you to spend more at unexpected times. You need a plan that can easily adjust.
If not, you may get anxious and react emotionally, leading to costly mistakes such as panic-selling stocks at the market bottom, moving your entire portfolio into low-yield cash, or canceling long-term insurance you may need later.
So, how do you ensure your plan is adaptable? Structure your strategy into a three-bucket framework — short-term, medium-term and long-term — and make sure you hold one to three years of expenses in highly liquid vehicles, such as CDs, money market funds or high-yield savings accounts.
Additionally, review your portfolio once a year to ensure your asset allocation remains aligned with your risk tolerance and changing living costs. "Think through what you have and revisit your plan each year," said Riggs.
Building an inflation-proof retirement
Retirement isn't set in stone, nor should your saving and spending habits be. Inflation can crop up at any time, throwing a curveball to even the best laid out plans.
If there is enough growth in your portfolio, you have a withdrawal strategy that can handle rising costs, and you and your plan are adaptable, you should be able to handle whatever life throws your way.
Editor's note: This article is part of an ongoing series looking at three questions to ask yourself before making a major financial or lifestyle decision. The other stories in the series are:
Retirement readiness & life
3 Questions That Determine If You're Actually Ready to Retire Early
3 Questions to Ask Before Unretiring
Lump Sum vs Monthly Pension: 3 Questions To Ask Before Making a Permanent Mistake
Becoming the Free Nanny to the Grandkids? Ask Yourself These 3 Questions First
Where to retire
Moving to Florida or Texas for Retirement? 3 Questions to Ask First.
3 Questions That Reveal If You're Actually Ready to Age in Place
Thinking About Moving Near the Grandkids? Ask Yourself These 3 Questions First
Retirement savings and spending
3 Questions to Ask Before Deciding if a Roth Conversion Is Right for You
3 Questions That Help You Find Your Perfect Social Security Claiming Age
Go Ahead and Splurge, But Ask Yourself These 3 Questions First
Before You Give Money To Your Kids, Ask Yourself These 3 Questions
3 Questions to Ensure Your Retirement Nest Egg Is Inflation-Proof
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