For Mark Roberts’ Use: Inflation – the rise in prices of goods and services over time – can have a significant impact on your retirement budget. Once you stop working, you will most likely be faced with the prospect of living on a fixed income for the rest of your life. When prices of food, fuel, medications, and other necessities increase, you could find yourself stuck with a rather cramped standard of living.
Inflation is measured by changes in the Consumer Price Index (CPI), which records the average prices of various goods and services. During the Great Recession, the CPI dropped sharply. But now that the recession is over, CPI has begun to climb once again. If you’re thinking of retiring in the next few years, it would be a good idea to watch the inflation rate.
Sound retirement planning will help you to mitigate the negative effects of inflation. Treasury Inflation-Protected Securities (TIPS) are one financial planning tool that can help you fight back a rising cost of living. TIPS combines the earning potential of Treasury bonds with inflation protection, by indexing the value of the security to the Consumer Price Index. TIPS pay a fixed rate of interest on your current principal twice per year. At maturity, you will receive either the original or inflation-adjusted principle – whichever is greater.
When the CPI rises, the principal value of TIPS increases. On the other hand, the principal value will also fall when CPI drops. As with all forms of investing, you will need to make careful decisions about your tolerance for risk versus your desire to protect your principal. And unless your TIPS are placed in a tax-deferred account, you may be liable for income taxes on the interest each year.
TIPS can be a valuable asset to your overall portfolio, but careful consultation with your financial advisor and tax planning professional is necessary. If you’re interested in the potential of TIPS to help you navigate the rising tide of inflation, talk to your retirement planning advisor.