by Gary Foreman

Should retirees (and those who are nearly retired) pay attention to compound interest and inflation? You bet! If you or your spouse live a normal lifespan, you can’t afford to ignore the effects of inflation on the cost of the things you’ll buy or the compounding on your savings and investments.

A man reaching age 65 today can expect to live, on average, until age 84.2. A woman turning age 65 today can expect to live, on average, until age 86.8. And those are just averages. Some folks will live well into their 90s. (Source: ssa.gov) For a married couple aged 65, there is a very good chance that one of them will live into their 90s!

So even if you think you’re going to be ‘average,’ that means that you need a retirement financial plan that will last at least 20 years.

How compound interest affects the cost of things you’ll buy in retirement

So let’s see how compounding affects you over 20+ years. We’ll start with the cost of something simple like a loaf of bread. A popular loaf of sandwich bread currently costs about $2.

We’ll assume a 2% rate of inflation. That’s a low estimate. The last decade it was that low was the 1960s (2.04%). It’s been as high as 7.06% in the 1970s.  (Source: inflationdata.com). And we all know what inflation is doing this year.

With only a 2% inflation rate, that $2 loaf of bread will cost you $3.03 in 20 years. That’s when you turn 85. If you should live to be 95, that loaf of sandwich bread will cost you $3.70!

How about a pound of lean ground beef (about $4.50) today? In 20 years it’ll cost you $6.82 per pound. In 30 years you’ll pay $8.31 for the meat to make that meatloaf. That’s nearly twice as much!

The point is that even if you’re nearing or already in retirement, you need to plan for rising prices. Even a historically low rate of inflation will raise the prices of most everything that you’ll buy.

Now you may be saying that Social Security is indexed to inflation. And that’s true  (although some say that is doesn’t fully cover price increases). But what’s also true is that Social Security only replaces about 45% of the average retiree’s pre-retirement income. Which means that many of us are living very close to the edge. We need to watch each dollar carefully. Price increases can be painful.

Related: How Retirees Can Live on a Tight Budget

How compound interest affects your investment portfolio in retirement

Which leads us to the savings and investment side of compounding. You always hear that young people should begin to save for retirement as soon as they can. That compounding can work wonders if you give it plenty of time.

And that’s very true. If an investment grows at 6%, it’ll double every 12 years. $1 invested at age 29 will grow to $8 by the time you’re 65! So clearly it makes sense to start saving for retirement early in life.

But what about retirees? Hasn’t the compounding train already left the station? Aren’t we too old to take advantage of compound interest? The answer is mostly ‘no’. We’re not too old.

If you’re 65, you need to plan your investments for about 30 years. So if you’re investments grow at 6%, they’ll double every 12 years or 2 1/2 times. So $100 would grow to $300.

Which leads to the next question. Traditionally retirees are told to get much more conservative in their investment portfolio. Move from stocks to bonds and CDs. And that makes some sense. If you’re 30 and an investment goes bust, you have plenty of time to start over. That’s not true if you’re 65 or 70. You and I can’t afford to lose the money that we worked so hard to save.

But it’s also true that we can’t afford to let inflation slowly eat away our savings/investments while earning almost nothing in CDs. If inflation is 2% and you’re only earning 1%, you lose a percent every year to inflation. That doesn’t seem like much until you realize that it could happen for 30 years. That would mean losing nearly 1/3 of your investments!

How to protect your investible assets against inflation erosion

So what’s a retiree to do? If you have investible assets, there are three things that you can do to avoid the inflation erosion of your money.

1. Don’t be so quick to turn conservative. You don’t need to sell most of your stocks (or stock mutual funds) as soon as you stop working. Shift to a more conservative (i.e. more bonds/CDs) posture gradually over 20 or so years. The longer you own growth assets like stocks, the less harm inflation will do to your net worth.

Will the stock market go down during that 20 year period? Of course it will. In fact, it’s almost certain to go down. But, if history is any guide, it’ll also come back up again within a year or two.

2. Among your safer investments, have some that you can sell if the stock market tanks. The real losers in a down stock market are people who need income and have to sell stocks at their low point. If you have CDs that can be cashed in to provide that income while you wait for stocks to rebound, you won’t have to suffer those losses. When the market returns you can replace the CDs that were sold.

3. Include some hard assets among your investments. Things like gold, silver, and real estate, or funds that invest in those things. For many of us, equity in our homes is a big portion of our net worth. Be cautious that you don’t sell your only asset that appreciates with inflation. If you do downsize and become a renter, make sure you include some inflation protection in your asset mix.

• How To Minimize 4 Risks to Your Retirement Savings
• 7 Habits of Highly Successful Retirees
• Do Retirees Overemphasize Current Events In Retirement Planning?
• Should Retirees Consider a Life Settlement?
• Your Emergency Fund in Retirement: A Comprehensive Guide

Reviewed July 2023

About the Author

Gary Foreman is the former owner and editor of the After50Finances.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.