Protecting Your Retirement From Inflation
An edited version of this article was published
on the Channel NewsAsia website on 19 Dec 2022.
In this world nothing can be said to be certain,
except death and taxes.— Benjamin Franklin
This quote appeared in a letter Benjamin Franklin wrote to French physicist Jean-Baptiste Le Roy when discussing the new Constitution of the United States. We believe that Franklin might have missed out a third constant element of life: Inflation. It was not too long ago that Singaporeans had a rather apathetic attitude towards inflation but now, inflation has risen as a major topic of worry. What type of price increases can one expect over the long term? And how does one invest to keep up with inflation?
Price Increases
The chart below shows how a dollar’s worth of products has changed over the past 40 years. Amongst the categories, you will notice that education, transport, healthcare, and food have had the highest price increases over the years. Another insight is that the bank deposit rate is nowhere close to beating inflation, even for basic essentials.
You could argue that retirees are unlikely to bother with rising education costs, given that their children (if any) are unlikely to be at a school-going age. So, what do retirees spend on and what does their typical budget look like? This will depend on how basic necessities are defined and the type of lifestyle that they wish to achieve in their golden years.
A study conducted by the Lee Kuan Yew School of Public Policy shed some light on this topic. They identified the amount of income and the list of things needed for a minimum standard of living (by society’s standards). From this, you can then come up with the base income required to achieve that quality of life. The study showed that for people aged 65 and older, a couple needed S$2,419 a month, while a single person would need at least S$1,421. The top three expenses would comprise of food (29.2%), recreation and culture (19.7%), and housing and utilities (18.4%). The long-term inflation rates of those categories are 2.6% per annum, 1.2% per annum, and 2.2% per annum. So as a general guide, one should factor in these price increases when planning their future budget.
Keeping Up with Inflation: A look at various assets
The latest Singapore household sector balance sheet (Qtr3 2022) shows how an average household’s wealth is spread. Unsurprisingly, property forms the largest chunk (43.9%) by virtue of property being one of the largest purchases by Singaporeans. The next two biggest holdings are deposits and CPF (19.8% and 18.8%). Shares and securities form the smallest allocation at 8.4%.
This is a problem and here’s why. In his book, “Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies” Dr Jeremy Siegel, the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania, compares extreme long-term total real returns (i.e. returns from investment plus any income or dividends received, minus inflation) of various asset classes. He makes the case that amongst all asset classes, a broadly diversified stock portfolio provides the best chance for investors to preserve their wealth against inflationary shocks, nearly doubling in purchasing power every decade!
However, most people tend to focus on the short-term swings in stock prices which are driven by a multitude of factors like fear and greed, and thus prefer safer investments and cash deposits. As a result, they miss the broad upward trend in stock returns, thus underestimating inflation which slowly erodes their wealth over the years.
Which Are The Best Assets to Beat Inflation?
Research also shows which areas of the market have the best chances of maintaining one’s purchasing power over the years. In their 2021 paper, Dr Wei Dai and Dr Mamdouh Medhat from investment giant Dimensional Fund Advisors studied the relationship between inflation and the performance of global asset classes such as stocks, bonds, commodities, and REITs (see table below).
The data in Panel B which measured real returns (actual return minus inflation) showed that while returns from most asset classes were able to outpace inflation (which averaged 5.49% during high inflation years), there were clear winners. The only asset class which had a negative outcome were short-term treasury bills – equivalent to fixed deposits. This reinforces Siegel’s data earlier, showing that stocks provide the best chance of keeping ahead of inflation whereas holding currency in the form of deposits or CPF will lead to a gradual erosion of one’s purchasing power.
What About Property?
Singaporeans are generally property-crazy people and see owning property as the sure-fire path to long-term wealth. Many property investors further claim that it is a good hedge against inflation. On the surface, this appears to be a reasonable assumption. With a growing population, a finite supply of land, and the rising input prices of raw building materials, the value and rental yields on property should theoretically rise with inflation. But what does the data show? In reality, the link between inflation and changes in property prices while positive, is pretty weak. Owning property may indeed be a hedge, but it is only a weak one.
Comparison between Global stocks, Singapore stocks,
and Singapore Residential Property
We charted the inflation-adjusted growth of global stocks, Singapore stocks, and Singapore residential property from 1975 to 2021. After 46 years, property managed to grow from $1 to $7.62 in real terms. However, it lagged behind the Singapore stock market and the global stock market by a significantly wide margin.
Conclusion
Inflation will continue to be a slow and silent killer of our purchasing power over time. Unfortunately, most of us tend to have trouble visualising its effects except in periods of spiking inflation when it affects our pockets. It also compounds gradually over a very long period of time. With increasing lifespans and a fixed retirement age, retirement can last for 20 to 35 over years as more Singaporeans cross the centenarian line. Failing to consider inflation in one’s retirement plan may lead to the unfortunate situation where after a decade or more of retirement, you may suddenly find difficulty in making ends meet.
This is a wake-up call for Singaporeans who have shunned investing due to fears of losing money. Unless one is endowed with more than sufficient resources, the majority of Singaporeans need to take steps to ensure that their limited resources last for as long as they live, which has an unknown end date. By employing evidence-based investing strategies, having a retirement income plan that takes inflation into account is not as complicated as it may seem. But it does require one to invest time in understanding how everything may play out in the long term, and then taking steps to design an income plan that is not only able to beat inflation in the long run, but also provides sufficient liquidity to tide over short periods of investment volatility.
