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RISING INCOME IMPORTANT TO COMBAT THE EFFECTS OF INFLATION |
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When you're retired, inflation is your enemy. It eats away at the purchasing power of your money, particularly when you live on fixed payments from a pension plan or other sources, or your financial life is supported by fixed-rate interest investments such as bonds.
While this may not seem like a major concern at today's low inflation rates, the reality is that inflation does take a bite out of the lackluster returns many interest-generating investments now offer. And inflation won't likely stay low; the higher it goes, the greater the threat.
Inflation in Canada, as measured by the Consumer Price Index, has recently stayed well below the annual rate of 4.1% experienced over the past 50 years. But even that average is tame in comparison with high inflation years in the early 1980s, when annual increases in the cost of living were in double digits. In 1981 the annual inflation rate hit 12.4%.
Although 4.1% may not seem like much, it will reduce the purchasing power of a dollar in half in about 18 years. In other words, a dollar in 2026 would buy just half as much as it does today. An inflation rate of 10% cuts purchasing power in half in just seven years.
It's difficult for retirees to overcome the impact of rising inflation. When you're employed you can often rely on salary increases to offset an increasing cost of living. But retirees need to boost the savings they use to generate income or the returns from investments. The first option may be impossible, and the second difficult.
One of the best ways to protect yourself in retirement is to make sure investments that give you the potential for rising income are an integral part of your investment strategy. The return on your investments should exceed the inflation rate. The difference between the two is known as the "real return."
You can position yourself for positive real returns by holding a portion of your portfolio in shares of companies - or mutual funds that hold these companies - that have a history of increasing their dividend payments. Although dividends may be increased, decreased or eliminated at any point without notice, any rising dividends you receive may help offset inflation. Growth stocks are another way to have the potential for rising income. They have historically outpaced increases in the cost of living by a comfortable margin.
However, stocks and stock-based investments such as equity mutual funds entail more risk than the conservative interest-paying investments that many retirees favour. And the last thing you want to do when retired - or approaching retirement - is to put the wealth you've accumulated at risk.
That's why it's important to not go overboard with growth investments in your later years. You need just enough to provide rising income, while keeping the rest of your portfolio in safer, less volatile holdings. Edward Jones recommends that most retirees limit their growth exposure to no more than 20% of the overall value of their investments.
Your financial advisor* can give you more information about an investment strategy that can help you maintain rising income.
Edward Jones, Member, CIPF
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