Retirement may get you out of the rat race, but it puts your nest egg in a marathon run. It's called keeping up with inflation. A lot of investors and near-retirees may think inflation has not been much of a problem since the early 1980s. Not so. In fact, living expenses have crept higher for seniors than for all Americans in the past 20 years.
The Consumer Price Index measured by the U.S. Bureau of Labor Statistics (BLS) shows that, on average, prices for consumers overall rose 3.3% a year. But an index called the CPI-E (for "experimental") that tracks the costs of Americans over the age of 62 has increased at an annual average rate of 3.5% since December, 1982. Over that span, prices have risen 82% for most consumers while they've gone up 89.6% for older Americans. That means elderly investors have to rethink their strategies: "A lot of retirees want to go conservative, but with inflation, they don't have that option," says Fern Alix LaRocca, a planner with Advanced Financial Designs in San Mateo (Calif.).
Higher living expenses for the elderly are almost entirely a result of increasing health-care costs: Medical-care prices rose more than twice as fast as the average for all other items. "The elderly spend relatively more on medical care than the average consumer," says BLS Economist Ken Stewart. And no forecasters think health-care costs are going down.
Most retirement calculators aren't rigged with a CPI that adjusts for age. So many people could be underestimating the impact of inflation. Retirees are especially exposed to the corrosive effects of rising prices as they start to move from equities to fixed-income investments.
While bonds play a role in a retirement portfolio, equities should still make up the bulk of it. Sure, in periods when inflation spikes, equities have a hard time keeping up. But over the long term, they work as inflation hedges. A benchmark like the Standard & Poor's 500-stock index has, on averaged, returned 7.5% a year above the inflation rate during most of the period following World War II. Even if the real return on stocks slips to 5%, it still beat bonds.
ENERGIZED PORTFOLIO. You can tweak your stock portfolio to better meet your inflation-protection needs. If you're concerned about rising energy costs, you might allocate a little extra to oil and electric utility stocks. At least if you're paying more to gas up or run the air conditioner, you're making money as a shareholder in those companies. The same goes for drug companies. If you're concerned about prescription prices, buy pharmaceutical stocks.
As for bonds, consider Treasury Inflation-Indexed Securities (TIIS). The interest payments--made every six months--rise along with inflation. These bonds pay only about 3.5% a year in cash for a 10-year note; the big payoff is at maturity when the principal is adjusted for inflation. And you should keep them in a tax-deferred account, since the annual inflation adjustment counts as taxable income each year. You don't want to pay tax if you never received any cash.
Don't forget about real estate. Investors near or at retirement age should consider buying real estate investment trusts, or REITs, public companies that professionally manage a portfolio of real estate businesses. Charles Schwab's Investing Solutions Group, in particular, recommends apartment REITs. These portfolios of income-oriented properties, such as BRE Properties and AvalonBay Communities, can benefit from rising rents in inflationary times. If your housing costs are going up, at least you own a piece of a landlord who's collecting rent.
Investing in real estate other than your own home is a tough way for retirees to play this market. You plunk down a load of cash for a downpayment and closing costs with no guarantee of appreciation. "There's no liquidity in property," says Thomas Grzymala, president of Alexandria Financial Associates in Washington, D.C. "You can't take that unused bedroom to the supermarket to buy groceries."
By Mara Der Hovanesian