Whether you like it or not, the government has to spend money.  When the government spends money, it has to get that money from somewhere.  It can either get it from tax revenue, or it can print more money.

To increase tax revenue, the government will sometimes increase income taxes.  In my last blog, I discussed how to overcome the challenge of higher income taxes in retirement by utilizing the Roth IRA.  In today’s blog I’ll tackle the potential problem with printing more money: inflation.

Hurdle #2: Inflation

We are all very familiar with the effect of inflation, and if you need to be reminded, just ask a grandparent what they use to pay for a gallon of gas, a pair of shoes, or their first home.  We know that prices are going to go up in the future, so what can we do to reduce the impact inflation will have on our retirement plans?

Well, for starters, you have to remember that inflation is not always a bad thing.  Sure, no one likes to think about how much it will cost to see a movie in 2020, but who’s going to complain when they sell a house for $200,000 that they bought 30 years earlier for $75,000?  Inflation is bad when you have to BUY something in the future, but it can be a good thing when you have to SELL something in the future, especially when the item you want to sell increases in value at a rate greater than inflation.

If you think inflation is going to get in the way of you achieving your retirement goals, then here are some tips to get you back on track:

Tip #1 – Take risk

No, I’m not asking you to jump out of an airplane, but remember when you were young and adventurous?  Taking risk may have come easier then, but taking risk these days may not come so easily, especially when it comes to investing in the stock market.  But despite the uncertainty of the stock market, stocks have a history of outperforming inflation.  As a general rule, you should invest a percentage of your investment portfolio in the stock market equal to 100 minus your age.  So according to the rule, if you are 45 today, you should invest 55% of your portfolio in the stock market.  As you get older your portfolio would become more conservative, but you would still have exposure to the stock market.

Tip #2 – Build a hedge

Not the kind in your garden, but the one in your portfolio.  Look at adding some hard assets to your portfolio, such as real estate and commodities (e.g. gold, oil).  A well balanced portfolio will have anywhere from 10% to as much as 30% allocated to these types of assets.  Adding these to your portfolio not only help against inflation, but it can actually reduce the volatility of your overall portfolio.

Tip #3 – Ask Uncle Sam for help

He may not stop printing money, but he does offer conservative investments such as I bonds and Treasury Inflation-Protected Securities (TIPS).  These instruments provide safety of principal while increasing in value at the rate of inflation.  That way your dollar today will still be able to buy a dollar’s worth in the future.

Bottom line: Inflation is currently low, but it will likely go up in the future.  Take advantage of the years you have left to save by putting some of your money in assets that historically outpace inflation.