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Protecting Retirement Income: Top Investment Strategies to Beat a Low Cost of Living Adjustment

Inflation is one of few market forces that every investor needs to deal with. However, during the deaccumulation phase and during retirement, fighting inflation becomes paramount. To combat this, Social Security includes cost of living adjustments (COLAs) to help keep retirees’ heads above water.

The problem? These COLA payments often fall flat. And preliminary analysis suggests that next year could see another year of low COLA payments for retirees.

With rates of inflation and the main areas of retiree spending still running high, retired investors need to do something to keep their portfolios and income growing. Luckily, there are a few techniques and funds to help on that front.

A Big COLA Surge & Then Flatline

We all know that inflation spiked in 2022. Thanks to shortages and surging demand, prices from food to energy costs jumped to levels not seen since the 1980s. All in all, the consumer price index peaked at 9.1% in June of last year.

To fight that rise in inflation, Social Security has a mechanism to help increase payments tied to measures of inflationary changes. The program uses the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to figure out its COLA payments. That’s calculated a little differently than the bread-and-butter CPI we’re all used to. However, with inflation surging, Social Security recipients received a near-record 8.7% increase to benefits for 2023.

The problem is next year’s increase isn’t going to be very good. According to preliminary estimates by The Senior Citizens League (TSCL), 2024’s COLA should only be about 3.1%. That lower figure is because inflation has moderated since last summer.

However, the devil is in the details. As we’ve said, CPI-W is sort of a flawed way to calculate seniors’ expenses and inflation. All measures of the CPI track a basket of goods divided into the following categories: Food, Apparel, Transportation (including energy), Medical, Recreation, Education, and Other Goods. The issue is that CPI-W is actually weighted to look at the spending habits of young working adults—people in their 20s to 40s—so it overweights items such as personal services, gasoline, and electronics. It then underweights things like medical costs and breakfast cereal.

For seniors, this ends up being a raw deal and significantly produces a skewed COLA that doesn’t actually represent the goods they spend their money on. CPI-W-driven COLAs have averaged 3.4% annually since 2000. Actual cost of goods and services that seniors spend their money on have averaged about 6.2%.

How to Fight Back Inflationary Presure?

Aside from calling your local senator and complaining, retirees’ only option is having their portfolios do more of the lifting. There are ways to fight inflation and small COLAs.

Equity Funds to Boost Your Portfolio’s Cost of Living Adjustment

Bond Funds to Boost Your Portfolio’s Cost of Living Adjustment

For starters, focus on dividend funds. More specifically, dividend growth stocks. Historically, dividend growth in the United States has been more than the annual rate of inflation. Right now, the average dividend growth in the S&P 500 is 10.07%. The long-term average since the 1990s has been 6.8%. This cash in hand is a powerful tool to help keep a portfolio’s income growing. There are numerous ways to get your fix. The iShares Core Dividend Growth ETF offers a great passive choice, while the T. Rowe Price Dividend Growth ETF is actively managed to hone in on the best combination of value and dividend growth in the market. That strategy has worked, with the fund beating its passive rival.

Another choice? Own the producers of raw materials themselves. When prices are high for corn, coal, and crude oil, the ones who grow or pull the stuff out of the ground profit more. And in that, we get an expansion of multiples during high price environments. Buying a fund like the iShares North American Natural Resources ETF or Fidelity Select Natural Resources makes adding commodity producers a snap.

Third, betting on real assets has proven to be a good inflation fighter. Real estate and infrastructure assets like pipelines or toll-roads often come with rent/usage fees that rise in high inflationary environments. Cash flows from these assets often come to investors as high dividends. So, as inflation grows, so do the cash flows. The one-two punch of the Vanguard Real Estate ETF and iShares Global Infrastructure ETF could be all you need.

Finally, on the bond side of the equation, having plenty of exposure to short-dated TIPs and I-bonds can work wonders. Both bonds are very different in exposure, but provide inflation protection as rates rise. A fund like iShares 0-5 Year TIPS Bond ETF can protect your purchasing power and overcome inflation.

The Bottom Line

For retirees, inflation is a huge worry considering Social Security’s annual COLA payments often fall flat. With next year’s payment set to be another dud, investors need to take action. Betting on dividend stocks, real assets, and commodities, and having a hefty dose of TIPs in their portfolios, can help turn back the tide.
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May 22, 2023