Inflation and Retirement

When you consider how much you will need to retire you need to factor in future inflation estimates. Are you on track? Our online retirement calculators can quickly calculate how much you need to save for a comfortable retirement.

The price of groceries, homes, cars, petrol, insurance, etc., certainly aren’t what they were 20 years ago. It's clear, over the long term ongoing price increases can destroy the spending power of your retirement capital.

Even relatively modest inflation has the power to erode your retirement capital or a fixed income. Over a typical retirement term of 23 years, average annual inflation of just 3 per cent would halve the value of a fixed income.

How price rises erode your spending power

Compare this with how much income your current retirement arrangements will provide - our online retirement calculators can help you with this.

Inflation is VERY Real indeed!

Investors who lived through the 1970s know how destructive inflation can be, when annual inflation bottomed at a rather high 7 per cent before topping at 22 per cent.

Imagine, at the same time that your salary and income from your pension, savings, stocks and shares aren't rising by nearly enough to keep up with this kind of extreme increases in price level for (almost) everything.

Now that's really scary and, it may well happen again!

Mervin King, the Governor of the Bank of England, warned, earlier in February 2011, that inflation will remain high for the next few years leading to a substantial fall in many people's real incomes.

With the average worker's salary forecast to increase by little more than 2 per cent a year, unable to match the escalating the cost of living, millions of families will feel significantly worse off.

Mr King's warning came as official data revealed that inflation, as measured by the Consumer Prices Index, climbed from 3.7 per cent in December last year to 4 per cent in January 2011, the highest level for over two years.

This is now the 13th consecutive month that the Consumer Prices Index figure has been above the Treasury target of 2 per cent.

Many believe that the Retail Prices Index, rather than the Consumer Prices Index, reflects more accurately the true cost of living because it also contains housing costs. The Retail Prices Index increased from 4.8 per cent to 5.1 per cent in January.

Who is the major beneficiary of inflation?

Having a rather cynical streak, I believe governments, including the UK are likely to be rather keen to have inflation returning in the economy, and lots of it a.s.a.p.

Why?

Inflation demolishes debt!

As long as interest remain relatively subdued, the easiest way for the UK government to reduce its enormous debt mountain is to allow high(er) inflation to erode its real value.

Reducing these debts to "more manageable levels" by other means would take much too long. But a bout of so-called "controlled" inflation offers a great way to speed up the whole process. In particularly, if every other state is doing the same.

Of course anybody with large debts, such as mortgage holding homebuyers, "benefits" similarly. A fixed mortgage is obviously preferable at the moment,if secured at a favourable rate, as you will not (immediately, at least) suffer the inevitable rate rises as inflation goes up.

However, do realise that one person's debt is another's asset, so inflation merely robs the un-mortgage "haves" to pay the over-mortgaged governments and households.

So, who are the likely losers than?

Well, probably all of us, sort off . . . .

• people who are depended on their savings will see their savings capital eroding fast

• people on fixed incomes, such as retirees with annuities, i.e. whose incomes are not or only partially indexed to any of the above indices

• people saving for . . . well anything, in fact, including retirement

• all future retirees, that's you and me, as high inflation is generally bad for the stock market. The 1970s were a disastrous time for shares, with UK shares losing 40 per cent of their real value over the whole 12 year period.

Why is high inflation bad for companies?

Often companies can't pass on rising costs quickly enough to their customers, sqeezing their profi margins. Rising inflation eventually will force governments to increase interest rates, quickly tipping the economy back into recession, thereby effecting company results even further.

Valuation multiples that investors are willing to pay to buy shares will fall, as, present values of future cash flows will fall. As they did for most in the 1970s and early 1980's. For much of this period shares traded at very low price earnings ratios.

And the real winners are . . .

In my view, those investors and savers best placed to survive a bout of high inflation, if it continues for several years, and, even benefit of the coming turmoil, are the ones which are not only relatively cash rich right now but are also knowledgable enough to make timely investments in solid dividend paying shares.

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