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Inflation is the long-term threat stalking every portfolio.
The effect may not be very noticeable in the short run. But by the time you're deep into retirement, inflation can deal a devastating blow to your savings.
Inflation's impact is like that of high blood pressure -- that's what Francis Fennie of LPL Financial in Redwood City, Calif., tells his clients. "You may not feel it, but if you don't do anything to guard against it, it's massively damaging to your financial health over the long run."
Years of historically low inflation may have lulled consumers into underestimating the consequences.
But higher rates have finally arrived. Consumer prices have risen 3.2 percent in 12 months, the highest level in 2 1/2 years. That brings inflation back to near its historical annual average of about 3 percent.
Many financial planners find it hard to impress upon their clients just how serious a risk inflation can be.
Consider the case of a 65-year-old couple with retirement savings of around $600,000.
Financial models show they should be able to withstand annual inflation of 3 percent throughout their retirement, assuming they're collecting Social Security and able to earn an average annual return of 6 percent on their savings. But if inflation creeps up by just 1 percentage point, it's likely they would run out of money before both reach full life expectancy.
Even modest inflation is causing Marlis Risberg, a retired office worker from Forest Lake, Minn., to make some changes. The 70-year-old, who is divorced, started taking Social Security four years ago and finds that the $1,000 checks don't go nearly as far as they used to. She also has a small pension and some certificates of deposit, but it's all barely enough for basic needs.
"Gas, groceries, medical supplies -- everything's going up," she said. "You name me one thing that isn't, aside from the rates on CDs."
The impact of inflation on retirees tends to be higher than that for others too, especially in later years of retirement. A large chunk of their expenses tends to be from health care, and those costs are rising faster than overall inflation.
Ms. Risberg hears neighbors in her retirement community talk every day about how their income doesn't cover what they thought it would. Some are buying fewer groceries so they can afford their medications. Others are taking out reverse mortgages.
What can be done to offset inflation besides spend less?
For starters, you should acknowledge that inflation needs to be factored into retirement planning.
About 45 percent of retirees fail to account for the effects of inflation, according to a recent study by the Society of Actuaries. And only 5 percent of preretirees age 45 and older have a financial plan that extends to or beyond their life expectancy -- a long time span that gives inflation more time to erode a portfolio.