Retirees, both present and future, are likely aware that Social Security increases its retirement benefits annually in line with the country’s official inflation rate. What may not be realized is that these adjustments for the cost of living are not effectively matching the continuously increasing living expenses for seniors.
According to the Senior Citizens League, Social Security’s Cost-of-Living Adjustment (COLA) has not kept up with real inflation in most of the last 15 years. This has led to the average retiree receiving about $370 less in their monthly benefit than they should be receiving based on calculations.
In other words, seniors’ purchasing power with their Social Security checks has decreased by approximately 20% compared to 2010.
Alright, it’s not as bad as it appears at first glance. Social Security’s COLA In five of those years, inflation was surpassed in a technical sense, and at least equaled twice. The majority of the deficiencies can be traced back to only two years, specifically 2010 and 2011, due to a peculiarity in the method used for calculating these rises.
Nevertheless, these deficiencies have a growing impact that adds up over time. Compounding the issue further is the notable increase in medical expenses compared to other types of costs, which has a disproportionate effect on elderly individuals in the United States, as they generally need more healthcare services.
What should individuals do in this situation?
Ensure that insufficient cost-of-living adjustments do not erode your retirement savings.
Regardless of fairness, retired individuals in America cannot overlook their situation. A government program that provides financial assistance to individuals who are retired, disabled, or unemployed. The decrease in purchasing power of benefits will need to be counteracted by individuals themselves. They should look for investments that can generate income while also ensuring that the value of their capital is preserved and keeps pace with inflation.
An effective method to reach this objective is to invest in Treasury Inflation-Protected Securities, also known as TIPS. These bonds are issued by the government and provide interest payments that are adjusted periodically to align with fluctuations in the Consumer Price Index reported by the Bureau of Labor Statistics.
The strategy may be effective, but it has not been performing well recently. Five-year TIPS yields have been consistently low over the last two decades and have occasionally been negative. Meanwhile, the yields on 30-year Treasury Inflation-Protected Securities have not exceeded 2.55% during this period and are currently at only 2%. The market prices of these bonds also fluctuate to reflect changes in their actual interest rates.
While TIPS holders may experience temporary shortfalls in a specific year, their overall net returns tend to equalize over time. Despite this, it may seem like they are not fully keeping pace with inflation. However, in the long term, they do manage to stay ahead, albeit not significantly.
You have the option to possess these specific bonds issued by the government, but it may be more convenient to own a collection of them through an exchange-traded fund. ETF iShares TIPS Bond ( TIP 0.07% ) fits the bill.
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Traditional forms of these financial instruments may seem more appealing to you. The typical return on a 10-year Treasury bond is currently 3.9%, while high-quality corporate bonds are yielding around 5% before taxes.
Returns on these investments did not rise as fast as the high inflation experienced in 2022, and there is no guarantee that you will secure attractive returns when you are ready to invest. Additionally, these bonds do not account for inflation. You will only receive the interest payment and your initial investment at the end of the bond term. However, they may still provide a hedge against inflation. falling COLAs .
Just like with Treasury Inflation-Protected Securities, it is likely that an exchange-traded fund (ETF) that includes both types of bonds will be the most suitable option for the majority of investors. iShares 20+ Year Treasury Bond Exchange-Traded Fund ( TLT 0.46% ) and the Vanguard Intermediate-Term Corporate Bond Exchange-Traded Fund ( VCIT 0.13% ) , are both affordable choices.
With that being mentioned, it is possible that in order to beat inflation during retirement, you may need to consider taking on a slightly higher level of risk than what you had initially anticipated at this point in your life. This could involve investing in stocks, or more precisely, stocks that provide dividends .
Even during retirement, it is probable that dividend stocks will continue to be essential.
This might not be the update that certain investors were expecting. Nevertheless, it is accurate to say that stocks still represent the most likely way to at least match inflation over the long term. It is important to acknowledge that there could be temporary periods of market decline that you will have to endure in the interim.
There are a few methods to implement this strategy effectively during retirement. One option is to invest in dividend stocks that have a proven history of increasing dividends. Dividend Kings Companies that have increased their yearly dividend payouts for 50 years or longer. Similarly, a fund that is traded on an exchange such as ProShares S&P 500 Dividend Aristocrats® Exchange-Traded Fund ( NOBL 0.54% ) will perform well, as it targets stocks that have maintained a 25-year track record of increasing dividend payouts but not as high as others. The phrase Dividend Aristocrats® is a trademark owned by Standard & Poor’s Financial Services LLC. )
The dividend yield for the ProShares fund and the typical Dividend King stock is not very high. The ETF’s current yield is a modest 2.4%. Despite this, its dividend growth has consistently exceeded inflation, increasing by an average of over 10% annually in the last ten years.
Alternatively, you could choose to take a different approach by prioritizing a greater immediate return in return for potentially slower dividend growth in the long term. SPDR Portfolio S&P 500 High Dividend ETF is an exchange-traded fund that focuses on high dividend-yielding stocks within the S&P 500 index. ( SPYD 0.73% ) For instance, the company has a decent history of increasing its dividends, although it may not be very exciting. Despite this, with a current yield of 4.4%, you would be beginning with a higher yield that surpasses inflation.
Differentiate risk from volatility.
However, one must consider the possibility of owning stocks or stock portfolios. The element of risk is indeed present, so it’s important not to mistake it for mere chance. volatility However, the companies that back the equity ETFs mentioned are well-established and reputable. While they may face some ups and downs due to economic cycles, they are likely to recover and reach new peak levels over time. It simply requires being patient.
Alternatively, it might be wise to consider investing in all four of these exchange-traded funds to counteract the effects of inflation that Social Security may not fully address. Diversification is generally beneficial as it lowers your total risk and protects you from market fluctuations.
