Wealth+ Newsletter – 10.15.2021

Happy Friday! 

If you’re one of the 70 million Americans who receive either Social Security and Supplemental Security Income (SSI) benefits, you’re going to see your monthly checks increase 5.9% in 2022.

The 5.9% cost-of-living adjustment (COLA) will begin with benefits payable to more than 64 million Social Security beneficiaries in January 2022. Increased payments to approximately 8 million SSI beneficiaries will begin on December 30, 2021.

The COLA, which is based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), is the largest such increase since 1981 when the  COLA was 11.2%.

The estimated average monthly Social Security benefit payable in January 2022 for all retired workers was $1,565 before the COLA and $1,657 after the 5.9% COLA, an increase of $92 per month or $1,104 per year. If you factor in Medicare Part B premiums, which are deducted monthly from Social Security benefits, the average monthly benefit rises from $1,416.50 to $1,498.50, a net increase of $82 per month. Medicare Part B premiums for 2022 are projected to be $158.50 per month, up from $148.50 in 2021.

Also of note, an aged couple, both of whom are receiving Social Security benefits will receive on average $2,753 per month in January after the 5.9% COLA, up from $2,599.

Despite the increase, advocacy groups such as the Senior Citizens League say that soaring inflation this year (it’s now running 5.4%) has deeply eroded the buying power of Social Security benefits.

The study, which compares the growth in the Social Security COLAs with increases in the costs of goods and services typically used by retirees, found that, since 2000, Social Security benefits have lost 32% of their buying power.  Read the 2021 Social Security Loss of Buying Power Study. 

My take, however, is a bit different. According to my calculations, Social Security’s COLA has kept pace with inflation. For instance, COLA averaged 2.26% over the past 30 years while inflation averaged 2.3%.

But no matter whether Social Security benefits have lost one-third of their purchasing power or very little at all, inflation is one of the big risks in retirement, and you will want to manage and mitigate the loss of purchasing power. For its part, the Society of Actuaries (SOA) recommends investing in common stocks. But there are two problems with that solution. One, you’re trading inflation risk for investment or market risk, and two, stocks don’t offer great protection against inflation in the short term. If, however, you still have designs on investing in stocks to manage/mitigate the adverse effect of inflation, be sure to read The Best Strategies for Inflationary Times. The authors of that report found that “trend-following provides the most reliable protection during important inflation shocks.”

Experts also recommend that retirees include Inflation-indexed Treasury bonds in their portfolios – Treasury Inflation-Protected Securities (TIPS) and Series I savings bonds to their portfolios. An I bond is a savings bond that earns interest based on combining a fixed rate and an inflation rate. Read: October 2021 Will Probably Be the Best Month Ever in History to Buy I Bonds. TIPS are marketable securities whose principal is adjusted by changes in the CPI. With inflation (a rise in the index), the principal increases. With deflation (a drop in the index), the principal decreases. Read: Inflation Is Back: Any TIPS to Fight It?

The SOA also recommends inflation-adjusted annuities, but finding will be next to impossible.

What else might a retiree consider investing in to combat the loss of purchasing power?

Well, analysts are warning that traditional 60/40 portfolios could be battered by rising inflation.

And Goldman Sachs strategists are advising investors to consider using options to hedge protection against potential losses. One recommended trade is to sell calls on the S&P 500 to buy puts on the iShares 20+ Year Treasury Bond ETF (ticker TLT) as a way to reduce the elevated duration and rate-shock risk embedded in those balanced portfolios.

And Bank of America strategists are touting two trades in anticipation of a secular rise in interest rates, according to this report. One favors high-yield corporate bonds and floating-rate loans, over those with high rate risk such as Treasuries. And the second buys new-economy innovators that can benefit most from automation and capital spending to blunt the effects of inflation.

How much, by the way, should we be worried about rising inflation? Plenty according to the 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity chart, which, according to one expert, is suggesting that the market is pricing in the greater possibility the Fed has to aggressively hike rates to combat inflation.

In other words. It might be time to batten down the hatches.

Why Save for Retirement

My 23-year-old daughter recently graduated from college and started her first job. She was offered a chance to contribute to her employer-sponsored retirement plans – a traditional 401(k) and/or a Roth 401(k). She, after chatting with me, decided to contribute 10% of her salary to the Roth 401(k) and her company will match one-half of her first 6% of salary deferral. So, in effect, she’s now saving 13% per year for a retirement that’s like 47 years away.

Fast forward a couple of weeks to when she looked at her first paycheck after her 401(k) deductions kicked in. She was somewhat surprised by how little her take-home pay was and asked me what’s the point of saving now when perhaps she could be enjoying that money today.

So, I showed her the power of starting early and enjoying the power of compounding. Imagine, I said, that you’re earning (I won’t use real numbers) $100,000 and you’re deferring (including the company match) 13% of your salary in a 401(k).

How much will that be worth in 47 years? Well, it depends on which calculator you use. But, according to Bankrate’s calculator, she would have nearly $7 million set aside to fund living expenses for 30 years of retirement. Or put another way, she’d have more than enough funds for a secure retirement.

Another calculator (smartasset), however, shows a different result. That calculator shows she would $2.7 million at retirement but only have $2.5 million set aside at retirement. In other words, she’d have a shortfall of $200,000 and would need to increase her savings.

So, I tell my daughter there are two takeaways from this exercise.

First, no two calculators are the same. They all use different inputs and assumptions. So, it’s a good idea to use several calculators when trying to estimate whether you’ll have enough saved in the future.

And two, no matter which calculator you use (and trust), having somewhere between $2.5 million and $7 million set aside at retirement will make you happy you were more like the ant rather than the grasshopper.

Have a great weekend!

Bob