The financial shock of soaring inflation in 2022 caught everyone off guard. Within a matter of months, the price of rent, fuel, and countless consumer goods went through the roof. Having been in a period of relatively low, calm inflation for decades led us not to worry about this financial expense, until things went really wrong.

While inflation is now trending downward, inflation is historically always present, and there’s still a threat that unusually high inflation can rear its ugly head once again, especially given that most retirees expect to live another 20 to 30 years once they leave the workforce.

Fortunately there are several practical ways for retirees to protect themselves against inflation. There’s no “silver bullet,” but a combination of these can make it much more likely that retirees will weather inflation risk over a decades-long retirement.

Invest in stocks

Historically, stocks have provided a good hedge against inflation over long periods of time. While the sharp rise of inflation hurt stocks in 2022, stocks tend to keep pace with and even exceed inflation over the long-run as companies raise their prices on the goods and services they sell.

Some retirees believe risky investments, like stocks, are only for those in the “accumulation phase” of saving for retirement, and that once retirement is reached stocks can be sold and switched to less risky investments like bonds. While this may be the case for certain conservative investors with large retirement nest eggs and low spending needs, I’ve found that most retirees still need significant exposure to stocks throughout retirement.

Use TIPS

While stocks can be an excellent inflation hedge over long periods of time, they still expose retirees to significant volatility (ups and downs) in the short-term. Is there a way to keep pace with inflation but reduce some of that volatility? Say hello to Treasury Inflation Protection Securities, or TIPS.

TIPS are bonds issued by the U.S. Treasury with varying maturities, from several months to decades. The interest rate TIPS pay carries an inflation component which keeps pace with the rate of inflation. This inflation adjustment on TIPS resulted in TIPS’ rates paying significantly higher interest last year than usual. As inflation starts to cool, the TIPS rate adjusts downward as well.

I believe it makes sense for a good portion of retiree investment assets to be invested in TIPS. While they don’t experience the same appreciation of stocks which are also helpful for retirement portfolios built to last a decades-long retirement, their inflation adjustment and the interest they earn over time can be very beneficial.

Remember Social Security’s COLA increase

Among the many benefits of Social Security, the cost of living adjustment (also called COLA) is a standout feature. This translates to an automatic increase to your Social Security benefit based on the inflation rate determined by the Bureau of Labor Statistics.

Recent history provides an excellent example of the impact of this COLA feature. With inflation running hot in 2021 and 2022, the Social Security Administration announced COLA increases for those years of 5.9% and 8.7% respectively. That’s a whopping 14.6% benefit increase over just two years, taking a $2,000 per month benefit to $2,292!

The COLA feature accompanies your Social Security benefit whether you claim early or delay, but by claiming early you reduce the effect these and future COLA increases have on your monthly payments, which will last the rest of your life (and potentially your spouse’s life as well). As I’ve written before, it’s worth getting Social Security right.

Consider a COLA feature on your pension plan

At Hale Financial, we help many families who participate in the Wyoming Retirement System (WRS) pension plan. Among the many features of this plan, it also carries a COLA adjustment. Unlike Social Security, the increase isn’t a given unless you opt in to the feature. WRS offers a No COLA, 1%, 2% or 3% COLA feature which must be selected before starting your benefit. If opted into, the COLA is a guaranteed annual increase to your benefit.

While Social Security’s COLA increase tracks inflation and can therefore be a substantial “raise” in high inflation periods, note that WRS’s COLA increase only goes up to 3%. While this may leave WRS participants feeling shortchanged, it’s important to keep in mind that historically U.S. inflation has averaged around 3% annually. This means that opting into a 3% COLA on your WRS benefit can be a good way to at least track the historical rate of U.S inflation, which will help keep those pension dollars from losing too much value over time.

I hope this review of ways to combat inflation in retirement has been helpful. Among the many financial risks retirement may pose, inflation risk is one that’s often overlooked. The high inflation of 2022 was a wakeup call to many. Fortunately, retirees have several tools at their disposal to help mitigate the effects of inflation.