Risks To Your Financial Plan – Inflation

Risks To Your Financial Plan – Inflation


Hey everybody, Frank Iozzo with FMI Financial.
Today is part one of a three part series in which we’re going to be addressing
the three financial planning risks that everyone faces. Now today’s conversation,
we’re going to hone in on inflation. Inflation being the fact that the prices
of goods and services are going to go up every year. Now inflation risk essentially stems from
the fact that we have too much cash or we’re just generally too conservative,
and while I know the saying goes, “Cash is King,” the reality is is that too much
cash can actually make you a pauper. And so while we’re big advocates
of having emergency savings, where you decide to keep that balance
is going to be crucial in your overall plan. Let’s assume that the average annual
inflation rate is 3%, so our money needs to keep up at that pace in order to buy the
same things that we’re used to buying to maintain our lifestyle. Well, the average savings account yield is
0.09% per year. There’s clearly a gap between inflation and how
our cash is working for us. And that’s why it is very important that
we at least consider using a high yield savings account where we can get 1.5% to
2% on that same cash balance instead of next to nothing. But let’s assume that we keep our cash
in a traditional savings account getting next to nothing and how that
actually impacts us over the years. So let’s assume that it costs us $50,000
a year to sustain our lifestyle in 2019 and we have the vast majority of our
assets sitting in cash and essentially getting zero return. If we let that happen for two years while
inflation is growing at 3%, well now it costs us $53,000 to buy the same things
that we were buying in 2019 so we’re going to be forced to make
some significant cuts to
our budget to stretch those dollars so that we’re able to
still sustain our lifestyle. Now, if we let this happen
for a 10 year period, now we need over $67,000 to buy those
same services and goods and there’s just not enough cuts that we can make within
our budget to stretch those dollars and to sustain that lifestyle.
Now cash feels good. There’s a sense of security in knowing
that when you log into your account, whatever that balance was yesterday, it’s going to be the same today and it’s
not going to be impacted by any market movement. But the fact of the matter is if we
retire at 65, we build out plans for people to live well into their 90s so
you need that money to last you 25 plus years, and sitting in cash or being ultra
conservative just doesn’t going to cut it. You need some component of your portfolio
growing at a good clip in order to give you the chance to have those dollars
last you that long period of time. So this is something that we see very
often when we have people in retirement or very close to retirement and thinking
that they need a large portion of their assets in cash and the rest
of it essentially in bonds
and then a sliver of it may be in stocks that they just can’t
afford to be invested in stocks. The reality is you can’t afford not to
be invested in stocks given the time horizon that we’re
relying on these dollars. So while the strategy does need
to be relatively conservative because we are now relying on these
dollars to sustain our lifestyle, the fact of the matter is you should
have anywhere between 30% and 45% of your allocation in stocks to increase the
probability of these dollars being there for the long term and to give you the
purchasing power that you need to sustain your lifestyle. There are a lot
of emotional aspects when it comes to financial planning, and cash is
clearly one of those components. But hopefully this gave you some
perspective around how cash can give you a false sense of security and having too
much can cost you big time long-term. Thanks for taking the time to tune in. We’ll see you back here at
the next video. Take care.

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