Don’t let inflation be a distraction

SMSF technical expert and columnist for The Australian newspaper
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Inflation causes distortions and problems in many areas of a market-based economy like Australia.

So it’s a good thing that over the last 10 to 15 years, it has been quite low.

The problem with a low inflation rate is that it seems to have made many retirees complacent about its potential impact on their future lifestyle.

In my view, inflation is the biggest problem retirees face.  It’s a bigger problem than running out of money.

Over 30 years, prices have increased by a factor of three

In the last 30 years, the ABS has estimated that consumer prices have increased by a total of 292%.  That is, prices have gone up almost three times.

This result actually surprised me because I didn’t realise it was this high.

To help you understand what this means, here’s a simple example.  Today, many of us would spend about $3.50 on a cup of coffee.  Thirty years ago, based on this data, we would have only spent $1.20.

Obviously, some prices of consumer goods over that time have increased faster than this rate (for example private health insurance), whereas others have fallen over this period, (for example, some international air travel) while others haven’t changed too much.

This 292% increase is an average rise of about 3.7% a year over the 30 years, which doesn’t sound too high.

However, most of these price increases occurred in the 1980s, because in the last 10 years prices have only increased by 31.4%.

How much do you need in retirement?

Sometime ago, the Association of Superannuation Funds of Australia (ASFA) began estimating how much income retirees need to have a reasonable retirement.

For the end of December 2004, ASFA said that a couple would need $43,350 and singles $32,800 per annum to have a so-called comfortable retirement.  Importantly, these numbers assume you own your retirement home.

By September 2013, these numbers had increased to $56,404 and $41,197 respectively.

In percentage terms, these are increases of 30% for couples and 25.6% for singles.  Since 2004, ASFA has revamped its assumptions about how retirees spend their money because how we spend our money has changed. For example, during the last 10 years, people have been spending more on communications, such as mobile phones and the internet.

Over the same period, the official consumer inflation increase has been 27.6%.  ASFA is saying that the income needed by retiree couples has had to increase slightly faster than the inflation rate.

In its latest announcements about this retirement income data, ASFA says that recently there have been quite significant increases in electricity prices, property rates and charges, and water and sewerage charges. On the other hand, food and private health insurance costs were reasonably stable.

If inflation averages 3% a year over 24 years then prices will double. Obviously, during the intervening years, prices are also on their way up.

Assuming average life expectancies, health, occupations and leisure pursuits, anyone retiring before age 70 needs to assume that they will live for at least another 25 years.

Prepare for it

In my view, inflation is a slow debilitating disease and, unless retirees take action to allow for it, they run the real risk of going backwards. Because the drop in purchasing power occurs so slowly when inflation is low, there’s a real risk you mightn’t notice it until it’s too late and your standard of living is forever adversely affected.

Retirees need to think very carefully about what type of asset will generate income that increases faster than inflation so that they avoid its impact. Just as employees look for jobs that provide for regular wage increases to improve their standard of living and protect against inflation, retirees need their assets to deliver the same result.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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