Following two years of rising prices and a cost-of-living crisis, inflation rates are finally returning to more manageable levels.

However, this doesn’t mean that prices are reducing, only that they are increasing more slowly. Households and businesses have faced significant financial pressures due to high inflation and this may continue for some time yet.

But inflation in itself is not a bad thing. Steady, moderate inflation is a sign of a prosperous economy. We should not only expect it, but we should also plan for it.

As saving for your retirement is a long-term prospect, it’s worth thinking about how inflation could impact on your retirement goals. 

Make Realistic Assumptions
The first step in creating your retirement plan is to decide on the assumptions you should use. This includes:

• The rate at which your earnings are likely to rise,
• How your spending is expected to increase over time,
• The investment return you can achieve.

Inflation will factor into all of these assumptions. 

In terms of earnings, some people receive an inflationary pay rise each year. It’s usually better to err on the conservative side and assume an increase rate slightly below historic inflation. 

Most people don’t increase their spending at a fixed rate every year. Over a short period, controlling your budget can help to counteract the effects of inflation. But it would be a mistake to assume that your expenditure won’t increase at all. Over a 30 or 40 year retirement plan, building in a small annual increase in your retirement spending will give you greater flexibility later on.

Investment assumptions are also important for combatting inflation. In average economic conditions, if the headline return on your investments is 4%, this could mean that after charges and inflation, your funds are only just holding their value. If you want your money to grow in real terms, you will need to seek a higher level of return, and take a corresponding amount of risk.

Manage Risk
To allow your investments to keep pace with, and even exceed inflation, you will need to take some investment risk. There is no such thing as a no-risk portfolio. As well as the possibility of fluctuating investments, inflation is another risk that needs to be managed.

Based on a modest inflation rate of 2%, your money will lose around 10% of its purchasing power every 5 years. Compound this over a lifetime of retirement planning, and it’s clear that leaving cash in the bank is not a sensible option.

Inflation has the greatest impact over the long-term. The good news is that investing for the long-term means that your funds are more likely to beat inflation. While short term fluctuations mean that investments can lose money over short periods, historic data shows us that values do tend to rise over longer timescales.

Diversify Your Investments
The main asset classes are:

• Cash
• Fixed Interest Securities
• Property
• Equities (shares)

These can be further subdivided by geographical location and sector.

Assets can be affected differently by economic factors, of which inflation is one. Equities are most likely to exceed inflation over the longer term, but are also more sensitive to market volatility. 

While we have a good idea of how market forces affect the different asset classes, we cannot predict how and when this will occur, or how long a recovery might take. At any given time, there are multiple things going on in the world that could affect your portfolio. Attempting to judge and time the market is usually futile. 

The key is to hold a wide range of assets that do not all behave in the same way at the same time. This is known as diversification.

Properly diversifying your retirement portfolio can be a daunting task. Fortunately, there are several options available that mean you don’t need to choose the assets yourself, from multi-asset funds to bespoke discretionary managed portfolios. 

Increase Contributions
The easiest way to boost your retirement fund is to increase your contributions every year. Many people do this automatically if they are members of a workplace pension scheme and receive an annual pay rise.

But what if you were to increase your contributions at a higher rate, for example 5% or 10%? There is a good chance that you would not even notice. Remember, your pension contributions benefit from tax relief, so higher earners can claim further tax relief, meaning that a contribution of €100 can cost as little as €60 from net income.

Compounded over time, these annual increases can significantly increase your retirement pot.

Plan Your Income
Planning doesn’t stop when you reach retirement. Inflation will continue to affect your investments, and should be taken into account when planning your income.

If you have a defined benefits pension, your income will most likely increase every year, as will the State Pension. 

You can also use your pension to buy an annuity with index-linking. This provides a guaranteed, rising income every year. However, many retirees do not want to be tied into an annuity that they cannot change later, or control how any death benefits are paid out.

Most people will be reliant on invested funds to cover their retirement expenditure, either alone, or to supplement other pensions.

The following can help to protect your retirement pot from inflation:

• Make a cashflow plan to determine how much you can spend.
• Plan withdrawals so that you do not need to sell investments when the market is low.
• Keep an adequate cash buffer.
• Stick to your budget and try not to increase your spending every year.
• Review your plans regularly, and adjust as needed.