Living on a fixed income: why?

With inflation now higher than anything we’ve seen since the early 1980s, I’m seeing a lot of stories on how rising prices are hitting retirees especially hard. They often describe how rising prices affect “people trying to survive on a fixed income.”

There’s no denying that inflation is currently outstripping wage growth in the U.S., eroding our overall standard of living. And retirees don’t have the luxury of hopping to higher-paying opportunities in today’s hot job market.

But the truth is, a lot of the pain and suffering inflation is causing retirees today is self-inflicted.

I’m not talking about lower-income households, 60% of whom rely on Social Security for most of their annual income, and whose benefits are indexed to inflation each year. You can argue that the government’s definition of inflation is less than what many recipients actually experience – and I doubt many of us would want to trade places with them – but to say they are living on a fixed income is a misconception.

I’m also not referring to those on the other end of the socioeconomic scale, who are easily able to absorb today’s higher living costs simply by skipping a luxury purchase now and again. For these fortunate souls, inflation is more an annoyance than an obstacle.

The people I worry about are those who have made a conscious decision to venture into retirement largely at the mercy of an income that can’t possibly keep up with their living expenses. They opted for the fixed pension from their employer without considering any other payout option. Fearful of market volatility, they built an entire investment portfolio on the mirage of “safety” offered by fixed-income investments. Or worse yet, somebody bought them a fancy dinner and talked them into buying an expensive annuity with no provisions for future income increases.

And now perhaps – thanks to inflation that may not peak anytime soon – that pension check doesn’t cover all the bills anymore, those bonds have lost value due to rising interest rates, and the annuity salesman isn’t answering his phone.

Ask yourself this question: Would you take a job that offered you no raises for the next 20 or 30 years? If as I suspect, the answer is no, then why would you even consider doing what amounts to the same thing in retirement?

Why would you be willing to face two or three decades of rising costs with an income that isn’t also increasing? Why would you volunteer to be held hostage to a lifetime of inflation – whether it’s ten percent a year, or two percent?

If it were me (or the clients we advise), here’s what I would do. First, I would try to figure out how much I want to spend each year in retirement. I would subtract Social Security and any pension income from that number to see how much I’ll need to withdraw from my portfolio to make up the difference. And then I would use mostly high-quality fixed-income investments to fund those withdrawals for at least the next five years, possibly ten. Ideally, I’d want to have enough money coming due each year to pay for the following year’s planned expenses.

With the rest of the portfolio, I would look for investments that pay an income that has historically kept up with or exceeded inflation over the long term. My goal would be to use that cash flow to systematically replace some or all of the fixed-income investments as they mature.

Is this a risk-free approach? Clearly not. But I will gladly accept the day-to-day unpredictability of equity prices compared with the possibility of my purchasing power – and therefore my standard of living – slowly wearing away over time.

We haven’t had to think about inflation for quite a while, but now we do. And there’s a lot more to it than a free dinner.

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