Inflation is often described as the silent assassin of wealth.
It’s the biggest single threat to your future wealth and many people just aren’t aware of how significant a risk factor it actually is.
Well, it is and when it comes to your pension, it’s critical that you know about it, understand its effects and take the necessary corrective actions.
What is Inflation?
Inflation is the rate at which the prices for goods and services increase over time.
It’s caused by a general upward trend in prices resulting from spike in demand or an increase in the costs of production.
Either way, its net effect is the same: things get more and more expensive with the passing of time.
The main consequence of this is that the ‘real’ purchasing power of your money decreases as a direct result.
Consequently, any money you invest in your pension is also at risk of being devalued if doesn’t keep up. Inflation risk is perhaps the most commonly overlooked component of investing when it comes to pensions.
And it can be a very costly oversight because it has a very destructive impact on your wealth.
The Cost of Standing Still
Here is a simple example looking at its effect on a €100k sum over 25 years with inflation running at just 2.5%.
You can see here that the buying power of €100,000 is, after 25 years, reduced by nearly 46% to €54,054.
In effect, this means that the real cost of standing still comes to €45,946.
When you’re dealing with a time horizon of this nature, the idea of leaving your money ‘under the mattress’ or wanting to ‘play it safe’ is a not a good idea.
Inflation is relentless, like an ‘always on’ treadmill, and you’re either keeping pace with it or you’re not.
Keeping Up
In keeping our example above, if you want to maintain the real purchasing power of your €100,000 after 25 years, then it would need to grow to €185,394.
And this is just to maintain the future value of your €100k..
Achieving it requires active, ongoing involvement on your part and this is where a good advisor can really add value to your finanical planning.
Beating Inflation
There are 2 primary ways to beat inflation.
- Intentionally build the inflation factor into your long term growth assumptions and deliberately alter your investment strategy to outpace it. This will, more often than not, require you to carry an additional element of risk in order to achieve it because it won’t just magically happen on its own.
- Automatically index link your regular contributions so that your contribution figure automatically keeps pace by increasing at a set amount each year. This is can be done from the inception of a pension or, if you already have a fund in place, a matter of getting in touch with your provider and asking them to facilitate it for you.
If you would like to discuss your situation then get in touch today by calling 01 442 3929 or emailing me at kevin@thepensionstore.ie
Kevin Henry
2019 All-Ireland, Business All-Star (Pensions and Retirement Planning).