The chicken or the nest egg: talking to clients about saving during inflation

Key Takeaways:

• It’s a near certainty that prices will continue to rise indefinitely regardless of actions taken by the Fed or other political leaders. Therefore, its vital to utilize an approach to savings with your clients that embraces the reality of inflation.
• The Rule of 25 for retirement strategy suggests saving 25x the annual amount needed for spending in the first year of retirement, but it doesn’t account for the age when someone might retire.
• The 80% Rule states that you’ll need to replace 80% of your pre-retirement income. Variations suggest 70% may be adequate while others suggest 90% or more. The logic is that in retirement expenses will be lower, however this rule doesn’t factor inflation into the equation.
• Another often-cited rule of thumb is based on age-based milestones for savings. The strategy suggests having a specific multiple of one’s salary saved by certain ages.

For many clients, it can be difficult to make ends meet during periods of high inflation, let alone save money for retirement. Saving requires a certain level of commitment. Obviously, individuals and families must cover their basic needs, such as food and shelter, before considering how much to invest in retirement plans or rainy-day funds. Nonetheless, the need to prepare for the future can remain a high priority for many clients throughout their careers. Starting to save early may provide better outcomes and usually requires saving a lower percentage of income to reach one’s goals. It may also provide some flexibility to pare back on savings in inflationary times without derailing the long-range financial plan. Not all clients will have started saving at the beginning of their career, but it’s never too late to encourage them (or too early to encourage their adult children) to start saving for retirement. Often when people get a later start with savings, certain sacrifices may need to be made such as limiting non-essential spending or perhaps working longer than initially planned.

Reducing non-essential spending can also help clients in inflationary times. Eating at home more often, taking a staycation instead of an expensive trip, or skipping the afternoon visit with one’s favorite barista can help relieve pressure from the household budget. Ideally, this would allow an ongoing saving strategy to remain intact.

One of the biggest challenges for clients can be knowing how much to save. There are a variety of rules of thumb that you can use to provide guidance for clients and their families to help determine how much savings they will need to accumulate for retirement. Three of the more common ones are the Rule of 25, the 80% rule, and aged-based milestones. While each of these goal setting strategies have some value, they pale in comparison to comprehensive financial planning.

Rule of 25

The Rule of 25, sometimes called the 25x retirement rule, is essentially the reverse calculation of the 4% Rule for spending in retirement). This strategy suggests saving 25x the annual amount needed for spending in the first year of retirement. For example, if a couple projects spending of $40,000 in the first year of retirement, they would need to have saved $1,000,000 by the time they stop working. That $1,000,000 is savings should last for 30 years. While this is a simple means of determining a savings goal, it doesn’t account for the age when someone might retire. A person retiring at age 50 might need 40x the amount of the initial year’s spending while someone retiring at age 70 may only need 20X.

This rule of thumb also does not adequately account for inflation, particularly periods of high inflation. As prices rise, the withdrawal amount may no longer be adequate to cover expenses. If the withdrawal amount rises, the life of the portfolio will be reduced.

While there is merit to the Rule of 25 as an initial gauge for setting a retirement goal, it doesn’t go deep enough. It excludes items such as pensions, Social Security, and other potential income sources which may be significant components of a successful retirement for your clients.

80% rule

The 80% Rule states that clients would need to replace 80% of their pre-retirement income. Variations suggest 70% may be adequate while others suggest 90% or more. The logic is that in retirement expenses will be lower. For example, if a client is saving 10% of their salary and will no longer be paying payroll taxes, their income need will drop accordingly. The flaw in this logic is spending habits vary dramatically based on income levels, lifestyle, and longevity. Lower-income households usually have relatively low savings rates while high earners may be saving upwards of 25% of their income. In addition, not all clients will spend less in retirement. Some folks plan to travel extensively, build a dream home, pay for grandchildren’s education, or leave significant assets to charities or heirs. As a result, the expenses for some households may significantly increase in retirement.

The 80% Rule also fails to factor inflation into the equation. As prices rise, the income generated by this savings strategy may prove to be inadequate.

Age-based saving milestones

Another often-cited rule of thumb is based on age-based milestones for savings. The strategy suggests having a specific multiple of one’s salary saved by certain ages. This gauge often looks something like this for someone planning to retire at age 67:

This strategy is modified based on the age your client plans to retire. For example, someone retiring at age 65 would need 12X their salary whereas another who plans on retiring at age 70 might only need 8X.

While this rule provides some benchmarks, allowing your clients to determine where they are in relation to the gauge, it doesn’t factor in spending, longevity, fluctuations in income, or inflation. It’s merely providing a target.

A more meaningful approach – Holistic Financial Planning

Financial professionals typically utilize financial planning tools to create individualized plans for their clients, taking into consideration spending needs, retirement age, savings rates, inflation, longevity, life insurance, wealth transfer goals, and health care and long-term care costs. These plans will also factor in investment returns, Social Security, pension income, and other sources of income such as rental property or annuities. A critical step for any plan is a realistic, comprehensive spending budget and should be updated regularly as changes occur (such as the birth of a child or grandchild, career change, disability, loss of a spouse, etc.).

What’s that have to do with the price of eggs?

According to the US Bureau of Labor Statistics¹, the price of eggs increased from $0.86/dz in 1992 to $2.86/dz in 2022 and chicken went from $0.87/lb to $1.80/lb. Over that same period, the cost of electricity increased from $0.09/KWH to $0.17/KWH. Rent has increased on average by 3.13% per year over the last twenty years. Prices increase over time due to various economic, geopolitical, and environmental factors. It’s a near certainty that prices will continue to rise indefinitely regardless of actions taken by the Fed or other political leaders. Knowing this makes it vital to utilize an approach to savings with your clients that embraces the reality of inflation. During the working years, encouraging your clients to commit to saving as early as possible, doing so consistently, and sticking to it through periods of high inflation can help to ensure they have adequate retirement savings. While helping clients plan for retirement, budgeting for spending should be comprehensive and must take inflation into consideration.