Possibly the Most Popular Inflation Protected Investment

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If you work in the United States, you are privileged to be participating in what is probably the most popular inflation protected investment and that is: Social Security.

When you are considering your inflation protected savings, make sure to take Social Security into account. We are told that for most retirees today, this is the largest source of income they have and it would appear that this trend will continue for most of us as we move into retirement as well.

Raises for Retirees?

For retirees, it may come as a pleasant surprise that their benefits go up from time to time. It probably feels like they are getting an raise, but that’s really not the case at all. What’s actually happening is that Social Security is linked to an inflation index. When that index signals that inflation has happened, you are entitled to an increase in benefits to make up for it. You are not getting any more real value. It’s just a way to make sure that your money continues to have the proper amount of buying power based on changes in what the dollar can buy. Another way to put it is that you are merely able to continue to pay your bills as they go up over time.

An Important Planning Consideration

As we are considering our long-term savings, it’s important to include Social Security in the mix. It is likely that most of our income will be coming from this program when we retire. In order to determine how much income we will need in retirement from other inflation protected sources, we really should consider what Social Security will already be covering in order to get an accurate picture.

When we are planning for retirement, it is helpful to know how much money we actually need to live on first. That’s the amount of money that you must have to pay all of your bills. Since these costs go up and they are not something that you can decide to stop paying, the income for them must go up too, even when you don’t work anymore. If your Social Security income isn’t enough to pay for your needs, it would be nice to know that now before you retire, otherwise you may think you have enough money to retire when you actually don’t.

Getting an Estimate

Social Security Retirement Estimator
Source: Social Security Website

It’s extremely easy to get an estimate in order to help you with your retirement planning. The Social Security website has a calculator you can use called: The Retirement Estimator. It allows you to enter your Social Security Number and the amount of money you earned in the last year, then it uses the information as well as your income history from tax records to determine what you can expect to be paid each month at various dates of retirement. You can then take this information and compare it to how much your bills are today. That difference is the amount of income you will need to come up with in order to retire safely.

If you find that you are lacking enough money to live on, it means that you will need to keep saving now so that you can make up the difference. This amount should also be inflation protected so that you can keep up with your bills when you stop working.

If you find that you already have enough to live on based on your Social Security estimate, then you should probably consider what you can do to invest your money instead of merely saving it. That means that you probably don’t need to be as careful to have guarantees of inflation protection but may take a bit more risk since you probably won’t have to cash out your investments at a particular point in time to pay bills.

An Important Inflation-Protected Investment to Consider

When you use the Social Security Estimator. You will find that it gives you different numbers based on when you start taking your Social Security benefits. At the time of this post, it usually gives you three. One for early retirement, one for on-time retirement and one for waiting for maximum retirement age of 70. You will notice that there is a dramatic difference between taking your income early compared to waiting until you are 70 and this illustrates what might be the most simple and beneficial inflation protected investments a person can have.

It is estimated that by waiting to receive your benefits, you automatically receive an 8 percent increase in payout per year. You might be able to beat this on the stock market, but then again you might not. This may be the highest-paying, guaranteed, inflation protected investment we have, and it’s available to everyone if they will only wait to receive their benefits. It only works up to age 70, though, and then you might as well take the benefits because they don’t go up anymore.

The Good News

The great news about this investment is that you don’t have to do anything more than you are already doing in order to participate. Just keep working hard. In fact, your estimated income usually goes up when you earn more.

Second, since you already have Social Security, you are off to a great with your inflation protected savings.

Thinking of Retirement as Standard of Living Insurance

Professor Zvi Bodie of Boston University said something that really shaped my thinking about retirement savings.  He said that we should think about retirement savings more like we think about insurance.  When I tried that, I realized that it caused me to challenge the advice about retirement that I often hear and read about.  It exposed something that I was seeing that I knew didn’t seem right as I was planning for retirement.

Assurances are not Guarantees

Fund managers want you to invest in their products, but they don’t give guarantees.  They are careful to have disclaimers so that we understand that we could actually lose our money.  That’s worth taking time to consider.  Professor Bodie says that these management companies are in a far better position to understand risk management than the common person, yet they refuse to guarantee that you will even have your retirement savings when you need it.  They give assurances, but they refuse to give a guarantee.  Professor Bodie says that the reason they don’t give a guarantee, is that they can’t.  Instead, they leave the risk of the investment with the person who is least knowledgeable about what they are doing.

A good thing to ask ourselves is: “Why can’t they give a guarantee when they are managing the money?”  The answer is: “Because the investments they use are risky and they know it.”

Professor Zvi Bodie does a great job of explaining the problem here in his video:

Is it really Savings?

I think that there is terminology that retirement fund salespeople should not be using.  They often refer to the money that we put into mutual funds or the stock market and other volatile investments, as our “retirement savings.” In my opinion, the money we are putting into those kinds of investments are actually “retirement ventures.”  Since no one is committed to maintaining a specific amount of money in those accounts, I don’t think that it can legitimately be called: “savings.”

When we use the word “savings” we naturally think of money in a piggy bank or money in a banking institution.  In those places, our money is insured in some way.  Our piggy bank is locked in our house and our bank accounts even have deposit insurance from the federal government.  We naturally expect that when we return to our bank, we will find the same amount or more than we left in it, but that’s not how most “retirement savings” accounts work in my experience.

Unfortunately, we need to be on guard when money managers use the term: “savings.”

Guaranteeing our Savings

There are ways to guarantee savings, and some of them come at a cost.  We know that insurance has a cost because many of us have insurance for other things like healthcare,  our cars or a house.  Insurance costs something because someone else is bearing a risk for us.  When we think of something as important as our retirement, doesn’t it make sense to insure that it will meet our basic needs?  Sure there are things in retirement, like golf or fancy vacations, that we don’t really need.  I’m not talking about that necessarily, but what about food and medical needs?  What about the power bill or visiting family for Christmas?  Do we want to become a burden on our adult children when it can be avoided?

Zvi Bodie brings up an interesting point in another place.  He suggests that we consider the fact that we are willing to pay $1000 for fire insurance for our house even though it is very unlikely that our house will burn down.  The chances are very small, yet we still pay for it.   That’s because we believe that the seriousness of not having a house outweighs the fact that it is unlikely to happen.  What good a house if I am unable to live in it in because my retirement savings has disappeared?  It doesn’t really make sense to protect the house and not protect my income.

Two Categories of Retirement Funds

Thinking about retirement in this way leads to dividing our retirement funds into two parts.  One part is the part you reasonably believe you can’t do without in your old age.  The other part is for things that you hope for, but that are not critical to your survival.  When we divide it up like this, and get insurance for the critical part, it can lead to peace of mind knowing that our critical retirement needs are guaranteed to be there for us.

Guaranteed Retirement Options

When it comes to ways to guarantee the critical part of your retirement, you might be imagining a large piggy bank or perhaps a bank CD.  If you have been reading my blog, however, you know what I think about that.  Both piggy banks and CD’s are not usually inflation protected, which means that they are not a guarantee.  They fail to be a guarantee because you don’t know what the contents of your piggy bank will buy in 30 years when you need it.

There have been CD’s that were “inflation-linked” in the past but I have not seen any in the last few years.  Hopefully, demand for them will increase and they will be offered again in the future.

Social Security

One obvious form of retirement insurance is Social Security.  It is inflation protected and it’s definitely something to consider when thinking about your critical retirement savings.  Social Security is likely to go through some changes in the future, but I expect that something very similar to it will be available for a long time to come.  There’s more about this investment in the article: Possibly the Most Popular Inflation Protected Investment.

Company or Government Pensions

If you happen to have a job that offers a pension that adjusts your payments for inflation, you are in a good position.  When I say pension, I mean the old fashioned kind that doesn’t require that you manage the money and that does provide a written guarantee.  Pensions that don’t adjust for inflation, are helpful but they don’t guarantee that you won’t run out of money to pay your expenses in the distant future.

Be Careful With Insurance Annuities

Other insurance products are provided by insurance companies by way of inflation adjusted annuities.  I would just make sure that the inflation adjustments are connected to actual inflation and not a flat percentage increase each year.  It’s important to understand how much you are paying for that insurance up front too.  Beware: Insurance companies use the word “guarantee” in a similar way that fund managers use the word “savings.”  Make sure you know what they are actually guaranteeing.  Guaranteed percentages are not the whole story.  You also need to know the exact amount of principal the percentage is calculated against.  If the principle goes down with something other than inflation, it’s not much of a guarantee.  Also remember that if the guarantee isn’t in writing, it’s still not a guarantee.  Insurance companies do and have gone out of business.  Zvi Bodie recommends splitting up your funds between companies.

Home Equity

The Equity in our homes really is a form of inflation protection.  Because a house is a physical thing that represents one of our important needs, it’s automatically inflation protected.  Its value goes up with inflation because a house is still a house no matter what the value of money is.  Just having your home paid off is big part of insuring your retirement.

This presents an option for those who have no heirs or have no other choice.  Many of us spend our lives paying the bank to own a house.  The tables can be turned.  It is possible to sell the equity to the bank and have them pay you to live in your own house.  That’s what is called a reverse mortgage.

Once again caution is needed.  Make sure to read everything in any contract to make sure that the bank isn’t taking too much for themselves in the deal.  They may woo you with assurances that the remaining equity will go to your heirs, but I am told that this is often not the case because of high fees.  Again, there’s no guarantee.

Another thing to consider is selling your house to your heirs, with permission to continue living in the house as long as you can.  Working a deal with your loved ones could be a practical option and it can be a win-win situation with them.

Inflation Protected Bonds

My favorite option is to use Treasury Inflation Protected Securities and I Bonds for savings that I want to insure.  I do have to do a bit more work myself, but fees are low or non existent.  These are just boring government bonds that usually don’t make a whole lot of interest, but they do one thing very well: they protect long-term savings from inflation and that’s what I’m looking for when it comes to protecting the critical part of my retirement savings.

Further Reading

How to Buy an I Bond
If you are ready to get some I Bonds right now and protect some of your savings, I’ve made some step-by-step instructions to help you set up your Treasury Direct account and purchase your first I bond.