This week we examine ways in which inflation nibbles away at your retirement income, especially in light of the President's proposal for Chained CPI adjustments to Social Security. The formal title is Chain-weighted Consumer Price Index and it's a variation of how the government figures out what is what we would call "inflation." Either way, with the low rates on offer from CDs and other "safe" investments, investors who don't take action fall behind every year.
Unfortunately, the numbers show what most people don't want to face: the days of relying on Social Security plus a few stable bonds and CDs are long over. To earn decent and sustainable returns, investors must search beyond traditional safe havens.
Inflation Is Slowly But Surely Eating Away at Social Security
Adjustments to benefits are based on the Bureau of Labor Statistics' (BLS) CPI-W Index, measuring prices for urban wage earners and clerical workers. The idea behind the CPI-W adjustment is that since urban wage earners and clerical workers have constrained incomes, they will shop in a thrifty manner, similar to retirees. This makes sense to an extent, but in some categories, retirees will have greater expenditures. For example, older people will spend much more on health care and much less on new clothes. The phrase, "I've got socks older than you, kid" didn't come from nowhere.
Despite the Social Security Administration's usage of the CPI-W for adjustments, the BLS does track the expenditures of those aged 62 years or older through a separate index, called the CPI-E. In this index, greater weight is placed on items such as health care, while the importance of other items is diminished.
The BLS doesn't like to mention the CPI-E, because it shows a problematic truth. In fact, you can't even get the data online. You have to call the BLS and specifically get it – which we did. That's a strange requirement for an agency with mountains of other data available online. To create our chart, we simply tracked the difference between the CPI-E and the CPI-W to show the slow erosion in purchasing power.
While the average annual gap between price inflation for seniors and Social Security adjustments for inflation is only about 0.58%, that small amount adds up over time. Over the past 29 years, it's accumulated into a 16.7% difference – meaning a considerable loss in purchasing power. With the average US life expectancy at 78.5 years, the typical citizen drawing Social Security from age 65 on will see the purchasing power of benefits decline by 7.8% in his lifetime. Government officials always claim that Social Security is adjusted to inflation. In reality, it's adjusted to an index intended to follow inflation. If that index is off the mark – as our research indicates is the case – your purchasing power will also be off. As the graph shows, those differences always seem to favor the government, not the Social Security recipient.
AAA Bonds Offer Next to Nothing and CDs Perform Worse Yet
With the Federal Reserve pulling Treasury rates down close to zero, every other interest-rate instrument has been pulled downward as well – whether it's CDs or Aaa-rated bonds. As our chart shows, with inflation factored into the rate, CDs are offering negative returns. And the average Moody's Aaa-rated industrial bond pays only 1.4% after inflation. At the moment, savers are getting hit harder than at almost any point during the recession.
Initially, in 2009, the economy had a brief period of deflation that made bonds and CDs acceptable investments – for the moment. However, since then, it's become downright foolish to put your money in long-term CDs and nearly pointless for Aaa-rated bonds. Moving your funds out of CDs isn't an investment option anymore; it's a necessity.
Regardless of whether the President gets his Chained CPI or we stay with the CPI-W we're using now, we're still falling behind every year if we rely solely on Social Security.
But the question always comes back to "then where should I put my money?" The answer for more and more investors, particularly those at retirement age looking for income, is the stock market and in particular high yield dividend stocks. Of course the first problem you encounter is that most dividend stocks pay only quarterly, but your bills don't arrive quarterly and your you don't have the option of saving up the bills for three months and then making a payment.
Fortunately there is a solution. I've recently updated our ground-breaking dividend investment plan called Money Every Month. The plan is just as the name indicates: you get dividend payments every month from select dividend paying stocks. In this plan I show you how to set up your monthly payment plan and even which stocks to start out with, plus recommendations for those who are more adventurous. If you're interested, please read my newest report on the Money Every Month plan: click here.
Originally posted on Investopedia.com INVESTOPEDIA ULC ©2013