The Impacts of Inflation on Retirement Portfolios
In today’s market environment, many investors have seen their nest eggs dwindle by 20% or more and are concerned about meeting their retirement income objectives down the road. But individuals who are consistent in their economic assumptions may find a silver lining to this very challenging time.
While it might seem like cold comfort to investors who have recently suffered staggering market losses, in an economic environment such as the one we are in now where banks are failing and the global stock market has shed 40% of its value, people actually have more money now than they did a year ago. The logic behind this is as follows: when markets are down and unemployment is on the rise, people spend less. When people spend less, prices must come down to entice them to begin spending again. This kind of low-to-negative inflation scenario means that investors have more money today, in real terms, than they did a year ago.
Recognizing that the rate of inflation is a key assumption in virtually any retirement planning scenario, we thought it made sense to examine the forward-looking implications of lower-than-average inflation on retirement portfolios. Using Monte Carlo simulation, we tested the effect that inflation has on a fictitious couple’s retirement portfolio and their ability to withdraw money from that portfolio in future years under two scenarios. The conclusions may surprise investors who are acutely feeling the pain of the current economic downturn: an individual whose retirement portfolio suffered a 20% drop due to market losses actually has more money in absolute dollar terms at the end of their retirement period in a below-average inflation environment than they would have had if their portfolio had not lost 20% in value but inflation remained near its historical average.