Wrestling inflation

Inflation has always been a key risk for retirees, though, like many other factors, it goes through cycles. While inflation has moderated from its peak levels, it’s expected to remain elevated in the near future and limit central bankers’ ability to ease financial conditions. This will likely result in a bumpy road ahead for the global economy and financial markets.

So, what does this mean for retirees?

Market volatility and high inflation have many retirees worried about the impact on their retirement savings and whether their money will last throughout their retirements. High inflation erodes purchasing power, which can have negative consequences for retirees who are withdrawing from their portfolios, especially if they’re withdrawing in down-markets.

In this environment, retirees face two key inflation risks:

  • Expenses are rising faster than income.
  • Portfolios are depleting faster than planned because of higher spending.

Considering these risks, financial advisors must work with their clients to develop and maintain a comprehensive retirement plan and investment approach that is keenly focused on goals and hedging against threats such as inflation. High inflation is generally shorter term, and maintaining a focus on long-term goals helps shift retirees’ mindset.

Protect retirement income through planning

There are several ways advisors can manage the impacts of inflation on a retiree’s portfolio, depending on the retiree’s specific situation. Here are three potential areas to consider:

Delay Canada Pension Plan/Quebec Pension Plan payments. Income from government programs, such as CPP/QPP and Old Age Security, are indexed to inflation, even though these payments may not be enough for retirees to manage their monthly expenses.

Inflation also has a significant bearing on when to start CPP. Periods of high inflation are a good time to revisit the factors involved in deciding if CPP/QPP can or should be delayed. Retirees can also revisit their income needs and scale back on certain discretionary spending if certain expenses aren’t being met.

Vary withdrawal amounts in a down-market. Retirees might also consider withdrawing a variable amount from a portfolio, especially in a down-market, which may help manage the portfolio by not having to sell equities at a loss. This can be adjusted for market conditions or changing income needs.

Use a cash wedge/bucket approach. This approach requires having a higher allocation to cash (usually one to two years’ worth of income needs), which helps avoid drawing income from long-term growth investments. The other two buckets can be designated as discretionary (short term), which is used to replenish the cash bucket, and non-discretionary (long term), which helps the portfolio grow and offset longevity and inflation risks.

Construct retirement income portfolios for inflation

For retirees who are withdrawing income from their investment portfolios to top up monthly expenses, having a well-diversified portfolio is critical. To help offset the short-term impact of higher inflation, there are several tactical strategies that advisors can consider.

For example, based on the client’s risk appetite, having a higher allocation to equities can provide higher returns to offset inflation (expected long-term returns in excess of inflation). Advisors can also suggest their clients invest in short-term Treasury Inflation-Protected Securities (TIPS) or similar short-term bond products to address the effects of inflation.

Retirees could also allocate to equity sectors that may perform well during inflationary periods, such as energy and financials, or defensive sectors, such as utilities, consumer staples and health care. There is also the option to invest in specific asset classes that are less correlated with the broader market, such as real assets or commodities.

During times of high inflation, it’s more important than ever to maintain a strategic asset mix and rebalance regularly to ensure the retiree is still on track to meet their goals and objectives. Remember, even in a challenging economy, clients should be reminded to continue to focus on long-term goals and remain invested.

Inflation can’t be controlled; however, working with an advisor and implementing and maintaining a comprehensive retirement income plan can greatly reduce its impact on retirees’ investment portfolios and incomes.

Luc Lafleur is assistant vice-president of portfolio solutions with Mackenzie Investments.