Planning for retirement is a difficult process. It involves living within your means to produce capital that can then be saved for older age.
However, with current interest rates low, it’s arguably more difficult than ever for many to obtain an inflation-beating return from mainstream assets such as cash and bonds.
As such, investing in the stock market could be a worthwhile idea. It may help you to overcome a simple mistake many people make, which is failing to beat inflation on a consistent basis to build a generous retirement nest egg.
Generating a return that consistently beats inflation is a crucial part of planning for retirement. For example, if the returns on your capital don’t provide a return that’s above inflation, the spending power of your retirement fund will fall in real-terms over the long run.
This, essentially, means the amount of goods and services your retirement nest egg can buy each year gradually declines, which means you may need to save a higher amount to enjoy financial freedom in retirement.
At present, many people are finding it difficult to generate an above-inflation return from their capital. Cash, for example, offers an interest rate of 1.5%, or less in most cases, while investment-grade bonds may also fail to beat inflation over the medium term. As such, many people may see the after-inflation value of their retirement nest egg fall in the coming years. This could cause their retirement prospects to deteriorate.
One way of beating inflation on a consistent basis could be to invest in the stock market. Certainly, it’ll not beat inflation in every year until most people retire. It experiences downturns and bear markets at regular intervals that can wipe vast amounts from its value.
However, the track record of indexes such as the FTSE 100 and FTSE 250 shows they have produced high-single digit returns on an annualised basis over a long time period. This means with inflation currently around 2%, and expected to remain at that level in 2020, investors may be able to produce returns that are significantly above inflation over the long run. This may increase their spending power and provide their retirement fund with a tailwind.
Clearly, investing in shares is a much riskier proposition than having cash or bonds. However, by focusing your capital on companies that have defensive characteristics, such as a strong balance sheet and a proven business model, it may be possible to reduce overall risk. Likewise, investing in a diverse range of companies may also reduce the impact of negative performance from a specific stock on your wider portfolio.
Beating inflation may not be an easy task, but it’s highly worthwhile in building a retirement portfolio. Buying stocks could be a means of fulfilling your goal a simple and accessible way.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.