Milk is good for the body (and ice cream for the soul). It also teaches us what we need to know about investing for retirement. Are you near or already in retirement? Perhaps you are thinking about starting or rolling over your pension and 401k investment accounts.
Maybe you are eagerly awaiting or already enjoying your Social Security check. Still, you’ve got a nagging feeling about your investments. You’ve been taught by well-meaning parents that you need to be conservative in retirement and seek “income”. Never touch principal! Unfortunately, this approach glosses over one of the biggest issues in retirement.
To put inflation in context (we’re getting to the milk, I promise), first consider the two greatest risks in retirement:
- Not having sufficient liquid and/or short-term investments to cover short-term spending; and
- Not having sufficient long-term investments to cover the ever increasing taxes and ever increasing cost of living.
When thinking about investing for retirement, consider what a gallon of whole milk costs today and what that gallon of milk will cost in the future.
- You could buy the same gallon of milk, year after year. When you’re not looking, the milk man switches you from whole, to 2%, to 1%. After a decade or two in retirement, you’ll be drinking skim. While it will still be a gallon, it’s not the same thing (as any whole vs. skim taste test will prove). In this scenario your money buys less and less each year because you fail to keep up with general price and tax increases. Cash and fixed investments, such as CD’s and bonds are particularly susceptible to inflation over a long-period of time. A combined 4% inflation and tax rate will halve your purchasing power in just 18 years. A dollar will only buy you 50 cents worth of milk.
- Alternatively, you could buy a gallon of whole milk every year. If the cost of milk (inflation and taxes) goes up, you’ll still be able to purchase an equivalent gallon of milk 10 or 20 years from today. In this scenario your investments will generally maintain their purchasing power, year after year. While your account’s value will increase, it generally won’t buy any more milk than when you first retired.
- Your last option and the one that in the near term (see 2007-2009 bear market) can be scary, but in the long-term will likely have you buying that gallon of whole milk and occasionally adding some cookies. In this scenario your investments will generally maintain and increase your purchasing power over time.
Any of these three strategies may be appropriate given your particular circumstances and tolerance for short-term market swings. Generally, we feel that the first scenario is also the most risky for today’s retiree. After working for many decades to accumulate assets for retirement, an income strategy such as this may significantly diminish your income later in life along with any inheritance you wish to leave for children or grandchildren.
So what will it be…milk that’s diminished over time, milk that stays the same, or milk with an occasional cookie (and consequently some occasional heartburn)?