While it’s not always the case, when you’re still working, you tend to get raises that adjust to the rising cost of living. This helps keep employees making enough to match inflation rates. For those living in retirement, there is a similar program with regard to Social Security. Cost-of-Living Adjustment (COLA) is designed to help retirees in the system keep up with higher prices. However, the COLAs don’t always add up.
That’s the case heading into the new year.
After some of the largest COLA boosts, estimates for 2025’s adjustments are predicted to be some of the smallest in recent years. For many retirees, the adjustments higher won’t be enough to cover their needs. That means taking matters into your own hands is paramount.
A Predicted Small Increase
Arguably the biggest headline over the last few years has been the surge in inflation. The post-COVID snapback sent the CPI to levels not seen since the 1980s. For those in retirement and on Social Security, those higher prices were a big hit to wallets. That is, until the program’s COLA payments kicked in.
As an inflation fighter, Social Security has a mechanism to help increase payments tied to measures of inflationary changes. The program will adjust its payments to match the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). As inflation surged, Social Security recipients received a near-record 8.7% increase to benefits for 2023. For all of 2024, those payments increased by 3.2%.
That’s great news for those retirees who use Social Security as part of their income plans. What’s not so great is what’s predicted to happen.
The fact that inflation is dropping is sending COLA estimates for 2025 to its smallest increase in years. Looking at government data, non-partisan senior advocacy group, The Senior Citizens League (TSCL), predicts that retirees could see a very modest 2.63% jump in the new year. While the number isn’t set in stone, dwindling inflation rates have the potential to seriously impact retirees’ income. According to the CPI-W, prices actually fell during June for the first time. 1
I don’t know about you, but my grocery bill or what I pay at the pump hasn’t dropped. There lies the rub. The CPI-W could actually be a bad indicator for measuring inflation.
All measures of the CPI—and there are a lot of them—track a basket of goods divided into the following categories: Food, Apparel, Transportation (including energy), Medical, Recreation, Education, and Other Goods. The CPI-W isn’t exactly the best measure for those in retirement. That’s because it’s actually a measure of the spending habits of young working adults. As such, it overweights items such as personal services, gasoline, and electronics. It then underweights things like medical costs and breakfast cereal, things people in retirement actually spend their money on.
That’s a huge problem considering that inflation—while falling—hasn’t really gone lower. The CPI is still stubbornly stuck above 3%.
On Your Own
For those in retirement, this is a huge problem. If your income can’t keep up with expenses, that’s a recipe for dwindling assets or being forced to adjust lifestyle: being forced to choose between needs and wants or, worse, needs versus needs.
To that end, investors need to be active when it comes to inflation fighting with regard to their portfolios. The smaller COLA adjustment in the face of still high inflation is going to pinch many retirees.
The question is how to do just that.
For starters, retirees may want to consider inflation-protected bonds like Treasury Inflation-Protected Securities (TIPS) or I-bonds. These bonds feature principal and coupon payments that reset higher with changes to the CPI. This way, investors always protect their purchasing power. You can buy individual TIPS through the secondary market or directly from the Treasury. I-bonds can only be purchased from the Treasury.
Next, having more of your portfolio in dividend stocks could be the answer. Aside from the capital appreciation potential, dividend stocks tend to raise their payouts each year. Better still is that this rate has long eclipsed CPI. Historically, the rate at which stocks in the S&P 500 have increased their dividends per year has been just under 6%. That in itself goes a long way in fighting the effects of inflation on a portfolio. At the same time, total returns for dividend growth stocks have been robust during periods of inflation. As shares raise payouts, investors have historically flocked to these stocks to take advantage of the higher income. The inflation-fighting effect is compounded.
Finally, even adding a dose of commodities can be worth your time. Corn, oil, gold, etc. are often directly correlated with increases to the CPI. Having a swath of commodity exposure in your portfolio makes sense to fight rising prices. And it’s easy too. Thanks to a variety of exchange-traded funds (ETFs), adding a dose of commodities to a portfolio has never been simpler.
Investors may find it beneficial to include real estate investment trusts (REITs) to their portfolios. Thanks to rising rents, REITs have often been a great source of both inflation protection and income.
Putting It All Together
Given the lower COLA and the flawed calculation that makes it up, building your own inflation protection is key. There’s no hard and fast rule on how to do that. But if purchasing power protection is the idea that TIPS and I-bonds should perhaps be the biggest allocation of your inflation quiver, with dividend stocks, REITs, and commodity exposure rounding out the rest.
Luckily, all of these assets—minus I-bonds—can be also added via ETFs. With just a few tickers, you can craft an inflation portfolio to overcome the effects of a smaller COLA.
Inflation-Fighting ETFs
These ETFs are selected based on their ability to quickly build an inflation-fighting portfolio of four key asset classes: TIPS, dividend stocks, commodities, and REITs. They are sorted by their YTD total return, which ranges from 2.1% to 12.8%. Their expense ratio ranges from 0.06% to 0.85%, while they have AUM between $1.69B to $93.7B. They are currently yielding between 1.9% and 4.9%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| VIG | Vanguard Dividend Appreciation Index Fund | $93.7B | 12.8% | 1.9% | 0.06% | ETF | No |
| USRT | iShares Core U.S. REIT ETF | $2.34B | 6.2% | 2.1% | 0.08% | ETF | No |
| DBC | Invesco DB Commodity Index Tracking Fund | $1.69B | 4.6% | 4.7% | 0.85% | ETF | No |
| TIP | iShares TIPS Bond ETF | $18.8B | 2.1% | 4.9% | 0.19% | ETF | No |
Overall, the smaller COLA boost highlights a big issue. Retirees are on their own when it comes to fighting inflation. With that in mind, investors need to craft a sleeve of assets to beat inflation pressures. TIPS, with a dose of dividend stocks, REITS, and even commodities, can help win the fight versus inflation.
The Bottom Line
Retirees are getting some bad news. Their latest COLA increase isn’t going to beat rates of true inflation. That means they need to fight the effects on their own. Luckily, there are plenty of easy and low-cost ways to do just that. With a simple four ETF portfolio, they can fight inflation and eliminate the effects of a weaker COLA increase.
1 Barrons (July 2024). Social Security Checks Might Not Get as Big of a Raise Because of Cooling Inflation