The last six years represent the lowest stretch of inflation during the past 50 years. If you think that means inflation is no longer a problem, guess again: Inflation is still regularly picking your pocket.
Inflation has been below 2 percent in four of the last six calendar years, and in none of those years has it been above 3 percent. As tame as that sounds, inflation is still an unreformed thief, and you need to keep an active watch to stop it from preying on your retirement savings.
Why inflation is still a worry for retirement savings
Here are four reasons why you still need to worry about how inflation affects your retirement savings, despite the low inflation figures of recent years:
- Inflation is low, but savings account rates are lower. The low level of inflation would be more reassuring if it did not come as a time when bank interest rates had fallen to near zero. According to the FDIC, as of early 2014 savings account rates averaged 0.06 percent, money market rates were not much better and even five-year CD rates were well below 1 percent.
- Some forms of inflation are higher than others. Inflation is not an equal opportunity thief. Some costs, such as health care costs and education costs, have risen much more quickly than the general rate of inflation. If you have a substantial amount of those types of expenses in your future, you need to plan for a higher rate of inflation.
- Time is not on your side. Even harmless-sounding inflation rates have a steady, erosive effect over the long-term, and retirement saving by nature is a long-term game. In automotive terms, a stock market crash may be like a collision that damages your car in an instant, while inflation is like rust that eats away at the car over time. When you consider both the number of years you have till retirement plus the time you are likely to spend in retirement, it adds up to plenty of time for inflation to have a significant corrosive effect on your savings.
- The old normal might not return. When savings account rates first dropped precipitously as the financial crisis unfolded, the natural reaction was to assume they would bounce back in a year or two. However, the economy, stock market and housing market seem to have developed a dependence on low interest rates that may influence the Federal Reserve to do anything in their power to keep rates low for the foreseeable future.
Inflation-conscious savings strategies
Low interest rates have made even modest inflation numbers a problem for retirement savers. Here are two responses:
- A bigger, longer-lasting role for growth investments. The conventional approach was to employ stocks heavily for long-term savings, and then scale back as retirement approached. Low interest rates mean you should consider higher stock allocations and maintaining them longer.
- Educated consumers can beat back some inflation. Informed consumers can save on everything from checking account fees to travel expenses. Online resources can be your biggest ally in fighting inflation.
The economy in recent years has tipped the scales in favor of inflation over savings account rates. It may take some active intervention by retirement savers to tip the scales back.