Why Inflation, Not the Stock Market, May Be the Biggest Retirement Threat

People approaching retirement, as well as those already retired, have lived through plenty of market drops and sharp sell-offs. They know the stock market can lose value quickly under the right conditions, even if its long-term direction has historically been upward.

That is why many worry about entering retirement during a weak market. But the more serious challenge to a portfolio may not be market volatility at all. The quieter danger is inflation, which steadily erodes purchasing power.

The bigger issue: rising prices over time

Inflation can quietly reduce the value of retirement savings. An average annual rate of 2% to 3% may seem modest, but over the years it can significantly weaken what your money can buy.

Health care inflation is often even higher, and spending on medical care usually rises as people age.

Why stocks are not the main concern

Stocks can be volatile in the short term, but they generally have a tendency to rise over time as companies recover, consumers spend more confidently, and asset values increase.

Bonds do not always keep pace with inflation, and cash is certain to lose buying power over the long run. Retirees who move entirely into cash may feel safer, but they can face decades of shrinking purchasing power and give up the growth that stocks can provide.

That said, stocks still carry risk. Investors should avoid concentrating too heavily in a single company, and there are ways to diversify beyond an S&P 500 index fund. Still, holding only cash all but guarantees a long-term loss in purchasing power.

What an inflation-resistant portfolio can include

A portfolio designed to withstand inflation usually includes several asset classes rather than relying only on high-growth areas such as technology. It offers multiple ways to help offset the effects of persistent price increases.

Treasury Inflation-Protected Securities, or TIPS, I bonds, dividend growth stocks, real estate, gold, and commodities are among the assets often used in a diversified portfolio. Gold, in particular, has a long record as an inflation hedge. It has served as a medium of exchange for thousands of years and has at times outperformed stocks during periods of high inflation and geopolitical uncertainty. Many experts suggest setting aside 5% to 10% of a portfolio for gold.

The limits of Social Security COLA

Social Security benefits do include some inflation protection, but they are not a complete answer. The cost-of-living adjustment, or COLA, is tied to the consumer price index, which tracks inflation broadly and may not match the spending patterns of retirees who spend more on housing and health care. Because different categories rise at different rates, COLA increases can still feel too small.