When you’re saving for retirement, it’s easy to forget that the goods you’ll be buying years or decades from now will probably cost more, all thanks to inflation. It’s important to keep this in mind when planning the amount of money you’ll need during your after-work years.
Here are five ways you can inflation-proof your retirement savings:
Don’t be too conservative
It can be tempting to stow a greater percentage of your retirement income in low-risk bonds, especially as you get nearer to your retirement date. And bonds certainly should be part of your retirement portfolio. But too many people focus too much on bonds. They don’t look at the real return on these investment vehicles with the effects of inflation factored in. Because bonds are less risky, they also offer lower rates of return.
Say a bond has rate of return of 6 percent. If inflation is at 3 percent, that rate of return is really only 3 percent — a fairly low payoff.
That’s why it’s important to include some riskier investments, such as stocks, in your retirement savings plan. Yes, there is more risk that stocks will lose value. But stocks also have the potential of providing a far higher rate of return; one that will help overcome the rising costs that come with inflation. (See also: 7 Reasons to Invest in Stocks Past Age 50)
Do your research
Investing in just any group of stocks won’t help you overcome inflation. Certain companies and financial sectors thrive when inflation rises, while others tend to struggle. For instance, investing in retail stocks might not help you overcome inflation. That’s because retailers tend to struggle when high inflation makes the products they are selling unattractive to consumers. However, companies in the agricultural sector tend to do better when inflation is higher. Their stocks, then, are a better hedge against a rising inflation rate.
Invest in treasury inflation-protected securities
Treasury inflation-protected securities, better known as TIPS, are designed to protect investors from inflation. That’s because the return is tied to the Consumer Price Index. This is an especially useful tool for investors living on a fixed income, like retirees.
Say you invest $100,000 in TIPS. If inflation is 4 percent, your principal balance will now be worth $104,000 after a year. When TIPS reach their maturity date, investors get back either their original principal amount — what they originally invested — or one that’s been adjusted for inflation, whichever is greater. TIPS also provide a bit of interest income, paying this out every six months. Investors don’t have to pay state and local taxes on this interest or on the growth in principal, but they do have to pay federal taxes on that money earned.
Investors can purchase TIPS at no cost from the U.S. Treasury in $100 values. You might also be able to invest in TIPS when you invest in a mutual fund that includes them as part of their investment mix.
Invest in commercial real estate
The value of commercial real estate can continue to rise even if the stock market is struggling. By including investments in commercial real estate along with stocks in your retirement savings portfolio, you can build a diverse investment mix that you can then use as a hedge against inflation.
The easiest way to invest in commercial real estate is to put your money in a real estate investment trust, or REIT. With a REIT, you’ll be pooling your money alongside other investors in commercial real estate buildings such as offices and apartment properties. You can also invest in a mutual fund that includes commercial real estate assets among its investment mix. (See also: The Only 5 Rules You Need to Know About Investing in Real Estate)