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Three Ways to Cope When Inflation Rises

Prices are going up. It’s an inevitable fact that we are all going to have to deal with.

For most of 2012 and 2013, inflation stayed tepid, rarely topping 2% in any of given month, according to Consumer Price Index (CPI) statistics released by the U.S. Department of Labor. (For a view of inflation rates from 1913 to the present, see this chart from CoinNews Media.)

Taking a look at 2014, in the 12 months through April, consumer prices increased by 2% after rising 1.5% in March. This marked the largest jump since July 2013. Excluding volatile energy and food prices, the so-called core CPI jumped 0.2% in April after rising by the same number in March. In the 12 months through April, the core CPI spiked 1.8 percent, the largest increase since August 2013.

While some measure of inflation is good for the overall economy (Josh Bivens of the Economic Policy Institute blogs here about how lowflation in the core CPI is a signal of our economy’s continuing weakness), inflation, over time, can break a retirement portfolio. In short, after you retire and stop bringing in steady income, rising prices can seriously impact your quality of life over time if your nest egg isn’t able to at least keep pace with inflation. Here are three factors to consider when thinking about retirement planning and rising prices.

  1. Do the math: If you need a sobering reminder about the potential impact of inflation on your retirement, sit down with your fee-based financial advisor and simply do the math. Assuming you need $60,000 each year to live your retirement dreams and a 3% annual inflation rate, then in 10 years you will need more than $80,000 per year just to keep pace with rising prices.
  2. Diversify: Talk to your advisor about keeping at least some of your nest egg in investments with solid growth potential, at least during the first few years after you retire. One topic you will want to discuss is the option of looking at stocks or stock-based funds that have a track record of paying rising dividends over time. This could be a signal that the companies selling these stocks are strategically positioned to outpace inflation.
  3. Cash out: According to new research from State Street, retail investors are holding an average of 40 percent of their portfolios in cash, up from 31 percent just two years ago. When prices increase, holding cash, which earns an investor close to nothing, is like burning money. While it is important to keep some cash on hand to pay for unexpected expenses, you should also consider high-quality, fixed income investments that have a low default rate.