Lately there have been a lot of references to “stagflation” when describing the current economic outlook. Webster’s defines stagflation as: an inflationary period accompanied by rising unemployment and lack of growth in consumer demand and business activity. In other words, there are a lot of people who are out of work but prices are increasing like there is too much money chasing too few goods. What does this mean for your retirement planning?
Most retirees, or soon to be retirees, live on fixed incomes. That is, retirees don’t get a pay raise just because prices go up. Yes, you might get a small cost-of-living-adjustment on your Social Security but most other “mail box” money does not increase with inflation. What’s more, the money you’ve set aside for retirement grows only as fast as the earnings will allow, and generally these are below the rate of inflation. In the early stages of stagflation, judging from the limited times it has occurred, interest rates are generally very low even though prices are rising rapidly. This means your earnings on bank CDs and fixed-rate bonds are below inflation and your purchasing power (what your money will buy) is losing ground. But, you’re reluctant to move your money to the stock market or put it in real estate because they are generally depressed, or highly volatile, as well. So, how do you protect your retirement nest egg?
Unfortunately, you’ve received a difficult assignment because there are not a lot of safe harbors. You should immediately assess the risks you are taking with your investments — if you can’t afford the worst case outcome, you need to take action. Inflation and the erosion of your purchasing power is bad enough but add to that losses from investments and you might have a really dull retirement. What investments might be at risk? Any money that you’ll need in the next ten to twelve years that is currently invested in stocks, bonds, mutual funds, variable annuities and anything else that goes up and down in value with economic and financial cycles.
The next thing you look at is income taxes. Are you paying income taxes on your Social Security benefits? If so, how might you reduce them without lowering your lifestyle? Let’s see, you have a bank CD that earns interest which is included in your taxable income and boost income taxes overall as well as makes a larger share of your Social Security benefits taxable. Why not move this into a fixed, tax-deferred annuity that either pay you a fixed rate of interest or interest that is determined by a stock market index? You will pay no current taxes on earnings, there is no tax bite on your Social Security benefits and you have the guarantee of an insurance company that you’ll not lose money unless you cash in your annuity early. As an added sweetener, with an index-linked annuity you’ll get the opportunity for an above-market return while avoiding the possibility of market losses.
The last way to protect yourself is to divide your retirement money into segments. The first segment will be the money you’ll be using in the next five years. This money will need to go into safe investments and be readily available. This means you’ll be forced to stick with bank CDs, money market accounts and possibly money market mutual funds. Stagflation is going to have an impact on this money and there is little you can do except hope for a near-term economic turnaround.
The second segment is where you put your annuities to get the tax deferral and the opportunity for higher earnings without sacrificing safety. This is the money you’ll need in five to fifteen years from now.
The last segment is the money you’ll need in twelve years and beyond. I’m assuming you have enough for this segment, if not you’ll simply place none of your retirement money here. Since it is reasonable to expect economic and market cycles to work themselves out over a decade or longer, you can afford to take a bit more risk; therefore, conservative mutual funds, diversified stock portfolios and other securities may be appropriate assuming you can afford the risk and sleep well.
You’ve just constructed a retirement ladder with your money. Each “rung” means that the money you’ll need during that time period will be maturing and ready for use “just at the right time”. You’ve minimized your taxes, lowered your risk, shelter more of your money from stagflation and diversified your investments. If all this sounds a bit too complicated for you, why not call your financial advisor and get professional help? If you elect to do nothing different in the face of changing economic times, then you’ll probably not sleep as well, have less to carry you through retirement and pay more taxes. What are you waiting for?