Key Takeaways
Despite recent spikes, long-term inflation is lower than imagined, so we'll maintain a conservative approach in our client planning.
Over the long term, U.S. inflation tends to revert to the Federal Reserve's desired rate of 2.5% to 3.0%.
Don’t let the headlines or recent hikes in gas and groceries derail your financial plan.
Don’t wait for things to “normalize” if you’re planning a big purchase.
In client conversations, the primary concerns often revolve around interest rates, the presidential election, and inflation. We’ll have more clarity around the first two issues in the coming months, but inflation has people worried and confused for the long term. Many of you have told me how skeptical you are about the government data saying inflation is running at 3% per year. You’re asking how that’s possible when everything seems much more expensive, especially at the grocery store, the gas station, and the auto dealership. Quite a few of you have said you’re waiting until things “normalize” before you buy a new car or make other major purchase decisions. But many of you have been waiting for things to normalize for over two years and that kind of thinking – like trying to time the stock market -- can wreak havoc with your financial plan and prevent you from moving your life forward.
As the chart to the left shows, even with a few brief spikes of 8% to 9% during the pandemic, the monthly (annualized) inflation rate over the past decade has stayed in that narrow 2% to 3% range. That’s why we’ll continue to plug 2.5% into most of our client’s long-term financial and retirement plans for day-to-day living expenses. That said, we’ll use a higher percentage for things like healthcare and education expenses, but again, 2.5% is very reasonable for long-term inflation daily living expenses.
Data Source: U.S Bureau of Labor Statistics.
Again, we’re talking long-term. There have been plenty of years in the 1990s and 2010s in which inflation was running at 2% or less (including as low as 0.7% in 2015) and that tends to average out the pandemic spikes we saw in 2022.
Let’s say you’re close to retirement age and your plan calls for drawing down $120,000 a year for living expenses ($10,000 per month). With the annual inflation adjustment, we’ll bump that up to $123,000 next year ($10,250 per month), and $126,000 ($10,500 per month) the year after that, etc. If due to changing life circumstances that amount no longer seems adequate, we recommend working longer, investing more aggressively, spending a little less, or using a combination of these strategies.
When new clients start creating retirement plans with us, we discuss various options and tradeoffs. We find it helpful to present different scenarios and explain: “Here’s what you need to do in each area—whether it’s spending less, saving more, or investing more aggressively.”
So, we ask new clients which scenario works best for them and start building from there.
It’s a collaborative effort. Again, we’re not trying to guess what inflation will be in five, ten, or twenty years. That’s like trying to guess where the stock market will be. Unless you’re living on a pension that’s indexed for inflation, regular meetings with your financial advisor to review how inflation is impacting your purchasing power and long-term financial health are advisable.
Yes, we're in a period of high inflation. I’m sure you’re feeling it in your wallet. But this too will pass, just like stock market volatility. Bumps in the road will happen and we’ve already accounted for them in the retirement plans we put together for our clients. Our assumptions are very conservative and based on years of experience. That’s when having an advisor (i.e., accountability partner) can be beneficial for helping you stick to your plan and avoid making hasty, emotional decisions that could derail your plan.
Conclusion If you or someone close to you has concerns about retirement or asset allocation, I’m always happy to assist.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners
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