Tips on protecting your pension and investments from inflation

Inflation, as a concept, deals with the rise (and fall) of prices in the economy. After spending much of the last decade flying under the radar, it has been centre stage for investment markets over the last three years. Higher inflation, both recently and potentially in the years ahead, can have a material impact on your pension.

Inflation in Ireland currently stands at 2.9% in April/May 2024, down significantly from its peak of 9.2% in 2022. While it is natural to focus on the everyday impacts of inflation, inflation can also have a significant impact on the purchasing power of retirement savings over the long term. It’s crucial to consider inflation when planning your retirement to ensure that your pension remains sufficient to cover expenses in the future. When you compare inflation at 2% versus 5% over a long period as we have in the graph then you can see its effect.

Why is inflation now more topical?

After falling sharply towards the end of last year, inflation has continued to decline in early 2024 but at a more gradual pace. Goods disinflation, which was the key driver of falling inflation in 2023, has moderated and energy prices are no longer adding to disinflationary pressures. Prospects for inflation hinge on the service components, where price pressures remain high amid robust demand, tight labour markets and above-trend wage growth.

Declining inflation is not just limited to Ireland, we are seeing this trend in the larger arenas of the US and the wider eurozone. Falling inflation is good news for central banks, which are either already cutting rates or getting ready to cut rates. Despite some stickiness on the services side, major central banks, including the Fed in the US and the European Central Bank (ECB), continue to signal that rate cuts will soon be forthcoming.

Between 1995 and 2020, the rate of yearly Consumer Price Index (CPI) in the US stayed in the range of 1% to 3%, with just a few minor deviations. In the European Union (EU), average inflation mostly varied between 2% and 3% from 1995 to 2012 and between 0% and 2% since. All this changed over the last few years. During the Covid-19 pandemic, amid a collapse in demand and plunging oil prices, global CPI declined significantly between January and May 2020. Since May 2020, however, inflation accelerated, resulting in the quickest subsequent upturn in inflation compared to the five global recession instances of the past 50 years.

In 2021, inflation rates began to exceed their target levels. Rising commodity prices and supply chain disruptions were the principal triggers of this inflation. As these factors faded, tight labour markets and wage pressures became the main drivers. The outbreak of the war in the Ukraine in February 2022, and its consequences for the markets for energy and food, massively accelerated this process. Major central banks initially viewed the rise in prices as ‘transitory’ and were therefore seen as slow in responding.

What does it mean in terms of reducing purchasing power?

Purchasing power is how much you can afford based on your costs and your income – including in your retirement. Inflation occurs when prices rise across the economy, decreasing the purchasing power of your money. Essentially the same euro amount doesn’t buy you the same basket of goods as it did the year before. In 2021 and 2022, when inflation was surging, wage growth was also rising but not nearly as sharply, leaving many people worse off in real terms.

In the beginning of 2023, over three quarters of professional firms in Ireland gave pay increases averaging 4%. This increase however, still lagged behind the rate of inflation in Ireland which stood at 8.2% at the end of 2022, although it has fallen back slightly since. With food price inflation and energy price inflation, even with the pay increases, most workers remained substantially worse off than they were due to a reduction in purchasing power.

What can you do to hedge against inflation?

The level of inflation in an economy can change depending on current events. There are many ways to hedge against inflation, including by increasing exposure to risk assets and increasing contributions.

Investors concerned about the impact of inflation on their pension and their investment returns should consider their long-term strategy, namely their investment horizon and their tolerance for risk. For many, the best course of action would be to maintain a globally diversified portfolio, by investing in multi-asset portfolios. One way to navigate times of inflation is through a broad mix of assets. Through Zurich’s actively managed multi-asset funds we can create the right balance of these assets within a portfolio. It is noteworthy that holding on to cash may reduce your future spending power, and this is even more predominant in today’s high inflationary environment.

You may see the value of your pension pot, and therefore your purchasing power for retirement annuity, falling as you approach retirement. People who contribute a set percentage of salary where that salary increases in line with inflation or increase contributions may be protected from the dangers of high inflation.

With inflation expected to fall further over the course of the year and central banks signalling that interest rate cuts will soon be forthcoming. Speaking to a Zurich Financial Advisor or your own Financial Broker will be helpful when reviewing and refining your strategy ensuring you are well prepared, and receive advice, regarding the impact of these themes on your pension.