Plan for retirement with inflation in mind

23 January 2024

How much savings are sufficient for 20 years of retirement spending? RM250,000? RM500,000? RM1 million? To live comfortably in silver age, your goal should not be merely to accumulate assets worth a nominal value. Inflation should also be considered to ensure an investment appreciates over the years, so its real purchasing power can satisfy your retirement needs. If an investment strategy is too conservative, the principal could be preserved at retirement, but its purchasing power may be eroded by inflation.

The destructive effects of inflation should not be underestimated, as even a slight increase (which compounded over the years) can lead to a heavy burden in retirement. However, its actual impact depends on changes in expected inflation and age. In simple terms, younger people are affected more because they are further away from retirement age, which means high inflation erodes their purchasing power over a longer period.

According to Manulife Investment Management’s calculations, suppose there are three investors aged 25, 45, and 65, respectively, who all retire at age 65 and have the same annual expected expenses after retirement. We found that:

• A 40 basis points (bps) increase in expected inflation will result in a 21.1%, 13.0%, and 5.1% increase in retirement costs, respectively.
• If expected inflation increases to 100 bps, retirement costs will increase by 53.0%, 32.6%, and 12.8%,¹  respectively.
  

Looking at it from another perspective, the three individuals must immediately increase the corresponding amount of savings/wealth in their retirement portfolios (i.e., increase their savings) to offset the effects of inflation so that they can withdraw the predetermined amount of real income (i.e., inflation adjusted) each year according to plan.

Manulife Investment Management calculations, as of January 2024.

It is, of course, not easy to inject a large lump sum into your retirement portfolio. If investors do not have spare or ready cash or choose to ignore inflation, the purchasing power of their assets will be heavily discounted in the future.

For example, if price levels rise at 2% per year, and the investment return is assumed to be 0% (holding cash and not making investments) and 1% (lower risk assets with an annual return lower than inflation) each year, real purchasing power (inflation-adjusted purchasing power of assets) after 35 years will be 50% and 29% less, respectively!

If the investment return rises to 2% each year, which is equal to the inflation rate, real purchasing power will remain the same throughout the investment period until retirement. Suppose the expected investment return rises further to 5% each year – in that case, your real purchasing power will increase continuously as the return is higher than inflation, and you will have gained 176% by retirement (see the following hypothetical example).

Hypothetical example: The effect of rising inflation on purchasing power

Assumptions:

• In 2024, an investor aged 30 has RM100,000 of assets and plans to retire at 65 (35 years later in 2059).
• In the same year, the price of daily necessities is RM100, and 1,000 units can be purchased with the assets held.
• The price of daily necessities (inflation) increases by 2% each year.
• There are four proposed retirement portfolios, with an annual expected return of 0%, 1%, 2%, and 5%, respectively.

Example for illustration only.

With inflation on the rise, if investors cannot inject more savings/funds into their portfolios but wish to avoid eroding their real purchasing power, they can consider postponing retirement.

Manulife Investment Management calculations, as of January 2024.

In the example above, if expected inflation rises by 40 bps, investors at ages 25, 45, and 65 would have to postpone retirement by 48, 31, and 13 months, respectively, to accumulate enough savings to cover their post-retirement expenses.

Conclusion

No one can control the rise and fall of inflation or accurately predict how prices will rise in the future. Investors should understand the effects of rising inflation on retirement costs and plan according to the above examples. Therefore, it is crucial to consider inflation when planning for retirement. The growing rate of an investment portfolio (portfolio return) should keep up with or even exceed inflation. As young investors will not be retiring soon, they can tolerate a higher level of risk. Therefore, their portfolios may focus on assets with a greater potential return, such as equity funds and bond funds.

1. Manulife Investment Management calculations, as of January 2024. This is a hypothetical mathematical illustration only. This is under certain assumptions about real interest rates and asset class returns of the multi-asset solutions team. Figures are based on assumptions as set out, and individual circumstances and objectives may vary.

Disclaimer

The above information has not been reviewed by the SC and is subject to the relevant warning, disclaimer, qualification or terms and conditions stated herein. Manulife Investment Management (M) Berhad Registration No: 200801033087 (834424-U) (hereinafter referred to as “Manulife IM (Malaysia)”) is a wholly owned subsidiary of Manulife Holdings Berhad and holds a Capital Markets Services License for fund management, dealing in securities restricted to unit trusts, dealing in private retirement schemes and financial planning under the Capital Markets and Services Act 2007. Manulife IM (Malaysia) operates under the brand name of Manulife Investment Management which is the global wealth and asset management segment of Manulife Financial Corporation. Information posted herein is intended for the exclusive use by the recipients who are allowed to receive it under the applicable laws and regulations of the relevant jurisdictions. Certain information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, estimates or other development trends of financial markets. There is no assurance that such events will occur, and actual results may be significantly different from what is contained herein.

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