Why You Must Consider Inflation When Planning For Retirement?
Updated On Jul 02, 2021
When it comes to retirement planning, one of the most important aspects to consider is inflation. The cost of living will climb not only while you're building up assets for retirement, but also during your retirement, which may last 25 years or longer. The above, leads to the conclusion that you will most likely not be earning a paycheck throughout your retirement, is the primary reason your portfolio must preserve some growth potential throughout your retirement.
In India, the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) are used to calculate inflation (CPI). Remember that even a 3% long-term average inflation rate hides periods of exploding prices, such as in the mid-1980s, when inflation was in the double digits. Despite the fact that consumer prices have been largely steady in recent decades, there is always the possibility that unforeseen shocks will lead prices to surge afresh.
Reasons Why Inflation Should Be Considered While Retirement Planning
Inflation is one of the biggest determining factors of how your retirement funds will behave. Here are the reasons why you should consider inflation rates while planning for retirement, keeping in mind how they impact your retirement:
Inflation Will Lead To Lower Investment Returns
Provident Fund (PF) and Public Provident Fund (PPF) investments may yield guaranteed returns of 8.5 percent and 7.1 percent, respectively. However, actual growth is estimated by taking inflation into account.
If the current inflation rate is 6%, then:
Real Return on PF Investment =8.5% -6%) =2.5% *
Holding a PPF yields a real return of 7.1 percent -6 percent =1.1 percent *
Even investments meant to build a savings account for retirement have a long time horizon. In this case, inflation refers to the possibility that the money obtained on investment will be worth less when inflation has been factored in. Investors should check to see if their investment returns outperform inflation.
* A rough estimate
Purchasing Power Is Reduced Due To Inflation Rates
The example above is straightforward and only examines the average rate of inflation. However, as previously stated, if food inflation is taken into account, the real return may be smaller or even negative. Suppose the current rate of food inflation is 10%, holding a Provident Fund yields a real return of 8.5 percent to 10%. (-)
1.5 percentage point
Holding a PPF yields a real return of 7.1% -10% = (-)
A negative return indicates that your money is eroding over time and that you can no longer afford even the items you can manage presently.
Long Term Future Costs are Difficult to Estimate
The rate of inflation is the sum of rates from various industries, goods, and regions. The overall figure is an average that may or may not be relevant to you unless you look at individual things or industries that affect you. Inflation is influenced by a number of factors, including resource availability, geopolitical impacts, market volatility, political stability, and the region's overall well-being. Past rates are not indicative of future rates, and even if they were, they have changed greatly (Source: Statista) from a peak of 13.48 percent in 1991 to a low of 3.83 percent in 2000.
There Is A High Risk On Fixed Return Instruments
Fixed-return securities such as bonds, deposits, and debentures have the biggest inflation risk. As a result, inflation has a particularly negative impact on retirees, whose monetization strategies are often fixed in absolute terms. Investors must allocate their funds strategically in order to earn higher profits. Financial institutions might consider balancing their portfolio with inflation-hedging asset types such as securities or commodity markets.
Inflation is an unavoidable threat to one's financial ambitions after retirement. However, if the effects of inflation are considered from the start, future retirees can actually take steps today to reduce their risks. The fact of the matter is to set a realistic retirement budget and invest in ways that will help to mitigate the effects of hyperinflation.
Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised not to rely on the contents of the article as conclusive in nature and should research further or consult an expert in this regard.