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Beating Inflation in Retirement

Beating inflation in retirement isn’t just an issue for old people anymore. Often times people hyper-save, invest and have a robust plan, allowing them to retire at a young age. Inflation is the greatest enemy to retirees, young or old.

Long stretches of a climbing stock market can give a false illusion of how much money you will have as you move through your retirement years. Inflation changes the formula and the math. If you retired close to the line where you pushed retirement forward, hoping the good times in your investments continue, there is risk of your money running out.

Inflation is a double whammy. Rising inflation causes interest rates to rise. While this may allow for some additional income on your money market funds, it also changes a number in the value creation formula. This means the stock market tends to struggle, if not outright decline hard. Look at a chart of the 1970s stock market (Inflation adjusted) to see how stocks react to higher inflation and interest rates.

S&P 500 December 1968 to July 1982: inflation adjusted. Source: Macrotrends.net

In this post we will discuss how inflation affects the 4% safe withdrawal rule, behavior that makes inflation a bigger or smaller problem for you personally, removing expenses without removing what you wanted in the first place and when to use do-it-yourself as an inflation busting tool.

4% Safe Withdrawal Rule and Inflation

For those unfamiliar, the 4% Rule is a simple rule of thumb suggesting you can safely withdraw 4% annually from your retirement accounts without depleting the account. Some people use the 4% Rule amortized over 30 years, some recommend using a life expectancy metric and the most conservative say you should never withdraw more than 4% in any year from your retirement funds.

The idea is to make your money last your entire retirement. $1 million under the 4% Rule allows for $40,000 of annual withdrawal that year. Once your retirement funds reach 25x (the 4% Rule stated another way) your annual spending you are ready to retire, regardless your age.

If only it were so easy. Interest rates and inflation have been tame for several decades. This allows us a false sense of security and exposes the limits of the 4% Rule. It is difficult understanding the acidic nature of inflation on wealth until experienced.

Many debate if the safe withdrawal rate should be 4.5% or 3.5%. This misses the biggest weakness of the Rule: Inflation.

Rising (and high) interest rates are generally not a good thing for equities (stocks). The value of future earnings are worth less when interest rates are higher and profits are untrustworthy when inflation is high.

• Example: If a company grows earnings at a consistent 10% those earning are reduced in value by the rate of inflation. Profits are in deflated dollars; dividends too. Plus, gains of 10% are zero in real terms if inflation is 10%.

Let’s exaggerate inflation and the stock market to better understand.

Assume you have $1 million and decide to retire. (Age does not matter so pay attention early retirees!) The 4% Rule under the most conservative method says you have a $40,000 annual safe withdrawal to avoid running out of money.

But now inflation comes along and cuts the value of the dollar in half! And the stock market has a nasty 50% bear market!

This happened in the 1970s. The chart above shows the damage.

If inflation is 50% your $1 million only has $500,000 of buying power now! And the stock market cut that in half!!! You now have $250,000 of buying power. Now what? Under the 4% Rule you can safely withdraw only $10,000 of buying power from your retirement accounts compared to before the inflation spike. Hard times, indeed. (In reality your account balance can be higher in nominal terms. But in real terms, after inflation, your buying power is reduced.)

In reality, the stock market can decline 50% rather fast. It is not unusual for a bear market to drop 40% or more. And it generally happen within a year, give or take a bit. Inflation in the United States is unlikely to run 50%, but in the 1970s inflation was high and stayed there. 50% wasn’t the annual inflation rate, but over several years our exaggerated example is reality. Something to think about as your prepare for retirement.

The 4% Rule might not be as safe as thought when adjusted for inflation.

There are answers to the inflation problem. Now I get to scold you gently as we make the necessary changes to beat inflation before and after retirement.

Take the sting out of inflation during retirement.

Changing Behavior to Beat Inflation

Inflation, prices overall, mean nothing to anyone unless they are buying something. You care less than zero about a surfboard if you are not in the market for a surfboard.

It is wants and needs that get us. Usually it is because we don’t know the difference.

Between my home and office is a coffee shop. Every morning I see people lined up all the way to the road to buy a $5 cup of coffee. Add it up and that is $80 per gallon. I think the cups are a bit larger so we can cut that in half to be fair. Still, $40 a gallon is a lot when you think about it.

We complain about $5 gas (I would argue some amount of energy consumption is a need in our modern world) and think nothing of $40 a gallon coffee.

This is a behavior issue. Coffee is cheap. I mean really cheap. My office gives free Keurig coffee to employees and clients. You even get to take the mug home with you if you want! My gym gives free unlimited coffee to members it is so cheap. And, of course, restaurants have the famous bottomless cup of coffee. So why are you paying $40 a gallon for the stuff?

We can make our own coffee for a lot less. Yes, it takes a few minutes. (Are we so lazy and entitled we will pay $40 and up for a gallon of coffee instead of a miniscule amount of work to get the same thing for close to free?) Yes, I can hear some of you complaining the coffeehouse coffee tastes better. You do know you can buy the same equipment and coffee to get the same thing, right? A Keurig machine has an upfront cost, but coffee is under $1 a cup, sometimes a lot less. (Brewed coffee is just fine, gentle readers. It was the marketing people that manipulated you into thinking otherwise.)

There is another observation on the lineup at the coffeehouse. Most of those vehicles are gas guzzling trucks and SUVs inhaling gas while people wait for their turn to buy overpriced coffee.

When did we decide we needed to drive a tank to work and around town? I hear the complaints again. Let me lay it out to see if I understand. A few generations ago when family size was larger a sedan did the job. Now, with fewer kids to haul around town, we need a massive SUV? And maybe 1% of those trucks are hauling anything. Something is wrong here. The current inflation might be a self-inflicted wound.

Some will complain about my observation and others are headed to the dealership for a fuel efficient vehicle. Neither reaction is proper.

The complainers know I am right and want to distract from the facts. Those motivated to buy a more reasonable mode of transportation need to tuck the wallet and take a deep breathe. No need to go from fire to the frying pan.

A new fuel efficient vehicle would be a solution. But we still have a working vehicle to think about. And vehicles are depreciating assets so I don’t like buying more of that asset class than I have to.

This is where a modest behavior change comes in. (And you are more than welcome to enjoy coffeehouse coffee if you want. Just no complaining about the price of gas.)

When gas is $1 a gallon, smart planning doesn’t pay as much because gas is so cheap. Now, gas being 500% higher, we have an attitude change.

First, if a medical condition does not prevent, consider walking and biking short trips. If you start to complain I will send you to the Mr. Money Mustache blog where he calls it clown-like car habits and says you are a whiny pants. He is right. Besides, a good walk or bike ride would do you some good (me too).

Plan your driving. A scattershot approach for errands only adds miles and requires more gas. A minute of planning can yield profitable results. Make one trip, not a dozen over the course of the day. This is also a good way to reduce stress and slow the pace of life.

I picked on the poor people frequenting the coffeehouse in Sherwood, Wisconsin and those driving SUVs and trucks. The rebuke was not meant to harm. The goal is to get you thinking about your behavior. Modest changes can add a wealthy lining to your life.

Now apply this way of thinking to other areas of your life.

Reduce waste to cut costs. Inflation is reduced when waste is reduced.

Waste

In the early days of this blog I tried to get the idea of frugality across. It’s a tough sale when stuff is cheap.

Now that stuff isn’t so cheap anymore, gentle readers need to take a look at those earlier posts. Buying Stuff Just to Throw It Away and Your Garbage is Killing Me should be classics that are read and re-read often. They are that important.

Depending on the study cited, 30% or more of food is wasted. Some studies include spillage on the farm while others measure food waste from the processor to the home. Regardless, food waste is a massive issue.

As I write, food inflation is running higher than overall inflation, beating even energy. Some energy use can be reduced, but food is a necessity any way you cut it.

Much of food cost is not the consumable food. A large percentage of the cost is processing, packaging and shipping. These costs can be reduced.

Buying local is frequently cheaper (and healthier) now that shipping costs are high. Avoid processed food (it’s bad for you). The size of the box hides the small portion of food inside. All that packaging has a cost and you are paying for it just to throw it away.

Fresh food is more nutritious and satisfying. That makes it cheaper (and more tasty). Less packaging and no processing. What’s not to like?

I’m not talking about recycling either. Yes, we should recycle what we can. But even better, buy less that needs recycling.

Waste drives me nuts more than any other foolish spending habit. It is senseless and yet people keep right on forking over hard-earned money.

Take an inventory of your garbage. Look at what you are throwing away. You will not get to zero garbage, but I bet you can find ways to reduce garbage, including recyclables. This will keep your money in your pocket.

Everyone is different. My job is to throw out ideas in the hope of triggering ideas that are pertinent to you. Here are two of those ideas:

• Laundry detergent is expensive and all those huge plastic bottles take energy to create, ship and recycle. You can make your own detergent for a few pennies a load. Just follow the link.

• Here are some intense ideas for cutting your electric bill up to 80%.

Learn DIY skills by working with craftsman.

Do-It-Yourself to Beat Inflation

There are many causes of inflation. Of course supply and demand are out of sync. That stands to reason. But lift the hood for the causes.

Under the current inflation spiral the causes are a host of bad behaviors. A pandemic disrupted supply chains and added stress to the system. Follow this with plenty of stimulus (too much money chasing to few goods and services). Then add a war and sanctions.

COVID started the ball rolling. It is understandable why governments wanted to provide relief for their citizens. But when the incentive to work is removed and demand for goods and services climb it is not hard to see why prices are moving higher.

All this could have been managed with only modest inflation. The real trigger is the Russian invasion of Ukraine. Sanctioning the world’s largest oil exporter is going to start an inflation spiral every time. All these events, capped with a war, and off to races we go.

People old enough and with a long memory might recall the inflation of the 1970s was sown in the late 1960s Vietnam War spending. All it took was an oil embargo and… Well, it starts to sound familiar.

The 70s were different. Stagflation was once thought impossible (like negative interest rates). This time is different from the 70s, but similar to most prior inflation spikes. That means inflation may not be as enduring as the 70s and more in line with inflation after WWII. The wild card? The Ukraine invasion. The longer the was goes, the longer energy sanctions remain. That is inflationary.

During the 1970s people had to cuts costs to survive. Growing your own food, even a window box garden, made a difference. Canning and dehydrating food became popular. This reduced waste as less was tossed. Grocery stores had less waste, too, as people bought produce grocery stores planned on throwing out for dehydrating or canning.

There is one difference this time. Nearly every employer is looking for more employees willing to work. People want stuff while retiring by age 30. The problem is not hard to see.

Recently I went to a local hardware store to repair a lawn mower tire. They had no employees able to do the work so they stopped providing the service. I did the job myself and saved some money. Not good for the economy, but good for me financially.

DIY is good for you. Learning to fix, build and repair stuff is a powerful wealth building tool. Don’t worry about the economy. The economy isn’t your problem.

Caution is always wise when DIY is involved. Some tasks might be outside your experience or skill sets. You can build those skills by volunteering for Habitat for Humanity projects. There are ample opportunities to grow your self-reliance abilities.

I can’t tell a broad audience what they should do. Every situation is different. I can, and do, encourage you to take steps to increase your DIY skills in areas that recur in your life. Some people will benefit from roofing skills; some not. Appliance repair is a massive money-saving skill. Minor plumbing is also a good way to save money. But you need to make sure you don’t bite off more than you can chew. And if you tackle electrical tasks be sure you know what you are doing. Safety first.

Striking up a friendship with a handyman is a good way to learn. Many projects need two people anyway so it works well for all parties involved.

I know inflation is really messing with readers. It is these trying times that determine how much wealth you have in the future. Understand the math of finances. Reduce waste, modify behavior where reasonable and learn DIY skills. All these things will serve you now as prices pressure the family budget and in the future when things return to normal. And yes, they do return to normal. Inflation resides and the stock market climbs again.

Take a deep breath. You can do this.

Further Reading

The Beginner’s Guide to Dehydrating Food Dehydrating food is fun and adds healthy snacks and meals to your diet. This is a good book to own if you are starting to dehydrate.

Curing Your Clown-Like Car Habit Think you can’t cut your gas costs in half or more? Here is an honest in your face look at driving habits from Mr. Money Mustache.

Hypermiling: Hybrid Mileage in a Regular Car Did you know your gas guzzler could get 50% better gas mileage? Here are the tricks to getting the value out of the vehicle you already own.

Bonus

Here are some money-saving tips to consider.

• Turn off the water while brushing your teeth.

• Take a cold or at least a cooler shower.

• Easy on heating and AC. Build a wider temperature comfort zone.

• Buy in bulk. But bring a calculator. Not all bulk purchases are cheaper. Marketers are masters at tricking consumers. Also make sure buying in bulk doesn’t lead to more waste.

• Take a garbage inventory. Review what you are throwing away, including recyclables. Avoid buying items you are throwing away. Packaging is always a big issue. Buy items with less packaging. It is usually a lower cost route.

• Embrace minimalism. You don’t need more stuff to make you happy. Less is more. Here is a great place to start: The Minimalists.

• Travel in non-tourist areas. Prices are lower, people are friendlier and you get to see the “real” world.

• Carpool.

• Add more frugal and money-saving ideas in the comments.

Ashish

Saturday 18th of June 2022

Most FIRE movements recommend investing mostly everything in S&P index funds like VTSAX, under today's circumstances - it is heavily impacted. Vanguard target retirement funds adjust investments as one gets closer to retirement but then gets lower return.

What is your take on these two approaches?

Keith Taxguy, EA

Sunday 19th of June 2022

Ashish, I prefer the S&P 500 index fund. Never trusted the target date funds. But that is just me.

Frank

Friday 17th of June 2022

Bengen's 4% rule actually accounts for inflation, as it requires the annual withdrawal be increased by the publicly reported inflation figure every year for an imaginary "average" consumer.

Which makes the strategies you outline even more important, because it is actually very easy for a retiree to lower their personal rate of inflation well below that of an "average" consumer. You'll slash it 1/3 just by owning your residence and having a fixed-rate mortgage or being willing to move to an LCOL. You'll slash it even more if you live close to the people and activities you spend the most time with and be more mindful of what and when you are driving. And even more if you do your travelling off-peak. A plane ticket for this fall is already selling for half or less of what one costs this summer.

If you have essentially zero shelter inflation and half your energy inflation, all you really have left is food, health care and consumer goods. Thus, almost any intentionally minded person can easily have a personal inflation rate that is half or less than published inflation numbers. And that probably solves most of any "inflation problem" for most retirees.

Stephanie

Friday 17th of June 2022

Another idea here! Depending on where you live, embracing the "Craigslist economy" can also be a great money saver (or Facebook Marketplace, or a buy nothing group, or whatever is popular in your area). Instead of buying new, develop a habit to first see if you can get it used - lets you have the fun of new-to-you with less pocketbook impact and less impact on the Earth.