Inflation and Retirement

It has been a while since my last post. I remind myself that I started this blog as a personal journal of my thoughts but have been too busy to write. Now I am in the holiday period at the end of 2021 and I finally found the time to write again about some interesting topics.

This post is going to be about inflation, particularly the high inflation that many places around the world have recently experienced. In the US where I’m located, I’ve seen the gas price go from around $3/gallon to $5/gallon in a few months. Prices of processed food have similarly risen. House prices in my area have gone up 10% this year.

Malaysia has registered an inflation rate of 3.3% in November this year. This, of course, is not meaningful at the individual level because everyone’s consumption of goods and services is different. What we see are things like prices of vegetables going up extraordinarily recently and it hurts when it hits the family wallet.

Will Inflation Stay High?

I belong to the camp that believes that the recent spike in prices is temporary, driven by private consumption trying to get back to pre-Covid levels but is being held back by global supply and logistics constraints as many countries still have some form of Covid movement restrictions. Eventually the Covid restrictions will end and supply chains will be restored. The long term trend of greater globalisation of production and the continuous advancement in technology is deflationary and this I think will keep long term inflation low. Furthermore, central banks of reserve currencies will not easily raise rates to levels in the past since their governments have accumulated so much more debt since the 2008 financial crisis and the Covid pandemic.

General Government Debt as % of 2020 GDP

Even when central banks were creating trillions of dollar during the onset of Covid-19, and some currencies started weakening, we did not see a corresponding spike in inflation. Instead we saw the money going into assets such as the stock market. This means without a corresponding rise in demand for goods and services, additional money created by central banks would not cause inflation by itself.

Retirement Expenses Rise with Inflation

We need to anticipate inflation when calculating how much in savings and investments are needed after we retire. Inflation works just like the compounding effects of investments, only in the opposite direction. If your investments return 8% annually but your personal inflation rate is 5%, then your investment is really only growing at 3%. This means that we need to aim for a rate of return for our investments that at least meets our personal inflation rate. If your personal inflation rate is 5%, you know that you shouldn’t keep all your investment funds in fixed deposits which has been returning less than 2% in interest. In the US, certificates of deposits have rates so close to zero I wonder why banks still offer these products.

When retired, we also need to factor in the rate of withdrawal from our retirement funds. In short, our investment returns needs to meet at least our personal inflation rate PLUS the withdrawal rate. If we aim to withdraw 4% of our retirement funds yearly and our personal inflation rate is 3%, then our investments need to gain at least 7% yearly for us to keep going. The Malaysian EPF dividend is currently below 6% so if this is your sole source of retirement funds then you can calculate how much you should withdraw yearly. Warren Buffet plans to leave his widow wife with his wealth in a low cost S&P index fund which returns historically 10%. I’d say she has plenty of headroom for personal inflation and withdrawals.

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