What inflation may mean for your retirement income

Yes, economies worldwide continue to gradually recover from the financial shocks of 2008 and the tremors that followed.

In terms of GDP growth, though, the recoveries are milder than the post-recessionary upswings experienced during the 1980s and ’90s. The term “jobless recovery” is thrown around a lot, because even though unemployment rates are falling, many of the jobs being created don’t match the quality of the positions lost.

One side benefit from this low-level economic malaise has been persistently low inflation rates, as measured by key indicators in much of the world.

That trend is expected to continue, with inflation projections from economists at major banks and universities calling for annualized rates to linger in the range of 2% to 2.5% until at least 2023. And some pundits say the pattern will persist until 2060 — in other words, past the life expectancy of much of the baby-boom generation.

Measuring inflation

Inflation projections are derived from the consumer price indexes of governments around the world. Calculations are performed by most governments by tracking price changes in a market basket of goods and services that people routinely purchase. If the goods in those baskets increase in price by 2% annually, that’s pegged as the country’s annual inflation rate.

The biggest problem with CPI measurements, though, is that they fail to properly account for many of the goods and services people need to live comfortably.

Owner-occupied housing, for example, is left out of many national inflation calculators, or it’s deliberately underweighted on the theory that it continues to provide service long after it’s paid for. While that may be true, it also distorts the picture of inflationary forces faced by people on lower and middle rungs of the economic ladder.

And, many economists opine both food and energy costs are improperly weighted in the indexes and, as a result, CPIs don’t properly account for the true cost-of-living increases people experience.

Meanwhile, many academic economists predict that a series of baby-boomer retirement waves will spur wage inflation as Gen X and Gen Y workers demand promotions and commensurate raises. While that will drive price increases, the process is expected to be gradual. Plus, it’s thought that the labour force shift will dampen annual gross domestic product numbers — which tend to correlate with an easing of inflationary pressures.

Hidden inflation

A bigger problem for Canadians living on fixed incomes is so-called shadow inflation, caused by currency fluctuations and seasonal dependence on imports. While we all enjoyed the loonie’s great run a few years ago, the average trading price for Canada’s currency has been around US75¢.

A persistently strong or strengthening U.S. dollar can create price pressures for consumables — particularly for fresh vegetables and fruits imported during several months of the year in Canada.

Currency spikes can also sharply impact the cost of electronics, clothing, books and personal-care products. These cost pressures effectively act the same way as real inflation. And, when consumers cut spending in response, they can have a direct impact on economic growth and job creation here.

Portfolio considerations

During the past decade, return rates for a balanced portfolio of equities and fixed income instruments have averaged between 5% and 6% annually, before accounting for fees and inflation.

Since investment returns are a function of risk, once those costs are accounted for, there’s not a ton of return left over in the types of ultra-conservative portfolios favoured by many older clients. Even a seemingly benign 2% inflation rate can cause problems for clients who have shifted toward capital protection.

That, combined with increasing longevity, suggests retired clients need to keep at least some risk in their portfolios after they leave the workforce.

Longer lives and import dependency mean a total risk-off portfolio is simply no longer an option.