Retirement planning and inflation

I've been working with retirees my entire 30-year career. I can safely say that I understand retirement, have a strong frame of reference for the financial behavior patterns of retirees and have gained a lot of experience with what works and what doesn't work when it comes to building and executing a successful retirement plan.

Over the three decades I have been working with and observing retirees I have formed the opinion that retirees tend to experience inflation differently than those still in the workforce and especially younger families raising kids. Its not that retirees don't experience inflation, they certainly do, it is rather in regard to how retiree households consume and make decisions in regard to inflation. Here's a couple examples.

First, let's talk about how the financial world gauges inflation. The government produces two key measures used to track consumer experienced changes in pricing, aka inflation. One is called the Consumer Price Index, or CPI, and one is called the Personal Consumption Expenditures Price Index, commonly referred to as PCE. Without getting too deep in the weeds in the difference between the two metrics, the PCE attempts to account for changes in consumer behavior in reaction to pricing changes. The PCE is considered a more holistic view of inflation and is the metric preferred by the Federal Reserve.

Now back to our retirees, in both inflation indexes shelter pricing (aka housing) makes up a material component of the index with the weighting of shelter in the CPI at 42% and in the PCE is about 23%. This makes sense with younger households who are likely to be dealing with rent increases, may be required to move for work purposes or may find themselves needing to trade up to a larger home as a family grows.

I find that retirees, however, are much less likely be subject to renting, are sometimes downsizing their housing needs, and while we are seeing more retirees moving homes recently, often times the moves are funded entirely with equity from their existing home as well as cash savings. In addition, many retirees have recently paid off their homes, or will pay off the home within the first couple years of retirement. Between these behavioral factors, it's not uncommon for my team to observe housing costs being greatly reduced for retirees, which makes using an inflation index based materially on housing costs, quite a bit less useful when it comes to planning for retirees.

Following housing, another large component of both the CPI and the PCE is food prices. Once again, while food is getting more expensive, retirees tend to just eat less of it, or more accurately, retirees tend to feed less people. In this regard I like to say, sure a loaf of bread costs a dollar more, or a dozen eggs two dollars more, but retirees are only consuming one or two of each per month. So, is the extra two to four dollars these food items cost annoying? Absolutely. But are the extra couple bucks per month a financial planning issue? That's a bit harder to sell.

Another big component of the CPI and the PCE is healthcare costs. Now you might say, "ah, Marc we have you now", and certainly retirees devote a larger portion of spending toward healthcare than younger folks. For the most part however, retirees also have Medicare and some sort of supplemental insurance products that provide for more healthcare expenses than they did even ten years ago. The big exception in this logic is prescription drug costs, some of which are outrageous, so while the retirees I work with are spending more on medical care, their benefits have also improved over time, offsetting a good portion of the inflation being experienced in this sector.

I could continue to go down the component lists for the inflation indexes and posit that retirees experience price changes differently, but there's one area where retirees don't have an advantage, in the price of services.

Services in the inflation indexes consist of items such as insurance, recreation and entertainment, travel, tax preparation and other financial services. In these areas I have observed that retirees have no advantage, and may actually be impacted by price increases more significantly that younger households. And right now, this is a problem.

It's a problem because service cost inflation is proving particularly stubborn in the current inflation cycle, with services inflation outpacing goods inflation for almost the entire inflation cycle that started in 2021. This has me concerned for the many retirees in my life, some of whom I have noticed changing behavior to "save money", by skipping desired travel or entertainment. I don't like it, and neither do they, and while I still don't feel inflation has become a material long term planning issue for the time being, my thinking just might be beginning to change.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.