The impact of inflation - yikes!

OldScientist

https://forums.moneysavingexpert.com/discussion/comment/82106973#Comment_82106973

I suspect the difference is mindset depends on how you are generating income in retirement (or vice versa?)

For those following a natural yield approach (e.g.., using dividends as income), real income will be variable but capital preservation (in the sense that the number of shares or units is maintained) is built in to the strategy.

For those following a total return approach with, for example, inflation-linked withdrawals (i.e., the so-called 4% rule aka 'safe' withdrawal rates) a constant income is built into the strategy (assuming the portfolio survives until death, which is not certain) with the amount left at the end dependent on chance.

To at least partially stay on topic, if anyone really want to scare themselves, use the BoE inflation calculator to calculate inflation over a 5 year period from 1970 to 1975 (annualised 12.1%, total inflation 77%) or any other period in the 1970s and 1980s. Retirees who had non-index linked income (e.g., a level annuity or DB pension) would have seen their standard of living shredded.

MK62

Maintaining the real terms value of a pension pot while taking a reasonable (relative to the size of that pot) annual income from that pot, would be challenging, at best, over the long term. It seems to me it would require a higher risk level than is prudent and a lot of luck......

Of course, if you can substantially vary the annual income you take from the pot (possibly to zero in some years) then that moves the goalposts in your favour....

That said, I agree with previous posters that this is not the goal of the majority of retirees, reliant (to varying degrees) on a DC pension pot......

SouthCoastBoy

I fully expect my pot to got down in value in nominal and real terms, and it is something I have planned for.

Currently interest on my cash is above inflation, which is a bonus I don't expect to last

mrklaw

https://forums.moneysavingexpert.com/discussion/comment/82107522#Comment_82107522

surely both would be the same outcome if you’re drawing on the proceeds?

dividend stocks will not grow as much as growth stocks, and you’ll draw on a chunk of the dividends. so there is inflation risk on the pot size unless you’re reinvesting a lot of the dividends.

growth stocks will be hopefully growing above inflation but then you’re selling down.

in both cases the portfolio size going up/down/flat will depend on performance and how much you draw

MK62

https://forums.moneysavingexpert.com/discussion/comment/82107196#Comment_82107196

One of the significant drawbacks to current inflation calculation methodology are the weightings used for various items, especially non-discretionary items (eg. council tax, water, energy etc).

This can lead to significant variations in the real inflation rate faced by different income groups, especially when those non discretionary items are rising far faster then the headline inflation rates suggest.

The average person on eg. minimum wage will be spending a much higher proportion of their income on those items than those with significantly higher incomes, and a much higher proportion than the headline inflation calculations suggest.

Cobbler_tone

The trouble with inflation as a raw measure is that it totally depends on your lifestyle. Whether you drive or not, go on holidays, your average energy bill, whether you have a mortgage, what your food shop is made up of, how much disposable income you have. A few percentage points can normally be mitigated by making different choices or compromising in certain areas. Without doubt, food inflation is the one people probably see/feel the most but it is still possible to shop efficiently.

Clearly, if you are on the breadline and living hand to mouth it will probably have a more significant impact. I tend to read that many people seem to overthink or worry too much. If the typical poster on here is genuinely struggling, then genuine poverty cases would go through the roof exponentially, whilst recognising there are plenty of people who do struggle and/or make poor decisions.

Moonwolf

https://forums.moneysavingexpert.com/discussion/comment/82106831#Comment_82106831

When apply for my annuity it was pointed out that the starting point for a level annuity is higher, in my case, at current rates of inflation it would be 18 years before the inflation linked one overtook the level annuity. I went for inflation linked but I can see how a plan for a higher figure in the “go go” years might be a good idea, particularly if the annuity isn’t your only source of income. Personally, part of the point was to take away uncertainty, but if I do survive to an age where I can’t manage holidays I’ll probably have too much income.

Andy_L

https://forums.moneysavingexpert.com/discussion/comment/82106973#Comment_82106973

the size of pot you'd need just to be able to live of the returns and not need to touch the capital means they'd be quite an outlier in terms of retirement savings (and/or how much they need form that pot to live off)

Linton

https://forums.moneysavingexpert.com/discussion/comment/82107842#Comment_82107842

In reality the situation is not as bad as you might think. The advantange of income investing is that dividends/interest are much more stable in £ terms than market prices. This means that you can quite easily get a steady income of say 6% of initial cost whereas Safe Withdrawal Rate considerations for capital could limit your initial level of withdrawal to 3-3.25%.

So an income portfolio can be about half the size of one designed for capital withdrawal and you would have money left over to invest in a growth portfolio to buy future income investments to meet inflation.

Managing your investments in this way avoids any need to worry about short term market movements with the result that you should be able to accept a higher % equity for the long term investments than would otherwise be prudent.

saajan_12

https://forums.moneysavingexpert.com/discussion/6680128/the-impact-of-inflation-yikes

Using CPI I'm worse off, using CPIH I'm treading water. I suppose I shouldn't be surprised given that I've had nothing coming in but it's still surprising to see how inflation eats away at savings over a relatively short period of time.

Whats the problem here? The point of investing money is so that it grows with the market, ie with inflation. Some investments may beat, others may underperform, but on average the idea is precisely to keep pace, ie 'tread water'. That way the money remains worth the SAME when you retire as it did when you deposited the money. If an average basket of investments was indeed performing higher than inflation, then that means the average price of things is higher, so inflation is higher. Now there's some nuance in which 'things' you're counting, but in general terms, unless you know something the market doesn't or are extremely lucky in your choice of investments, the expectation is to MATCH inflation.

If you then withdraw from your pension, it would naturally go down.. there's no guarantee that you preserve the pot in real terms AND draw from it, unless the pot is so big that your drawdown is a rounding error, or if you think your investments are particularly high performing.