How inflation can affect your 401(k)

Over time, prices tend to go up—which is called inflation. Because of inflation, how much you spend on everyday items changes from year to year, even if what you buy doesn’t. If you want to be able to maintain your standard of living in retirement, you’ll need to account for inflation as you plan how much you should be saving.

Inflation hurts your future purchasing power

To see why inflation matters—and why people say, “a dollar doesn’t go as far as it used to”—it's helpful to look at historical and current prices. Between 1995 and 2020, the price of a gallon of milk went up 30%, and a loaf of bread increased 57%. More striking were the 117% price growth for a dozen eggs and 172% increase for a pound of ground beef.1, 2

Sample price changes between 1995 and 2020

Chart shoes that the price of a gallon of milk, loaf of bread, dozen eggs, and a house have all increased from 1995 to 2020.

This sample is for illustrative purposed only.

In the last 25 years, general inflation—the overall increase in the cost of living—has grown nearly 75%.3 As the price of an item goes up (e.g., inflation), the value of the dollar in your pocket goes down.

The rate of general inflation is measured by the federal government’s Consumer Price Index (CPI), and it’s usually predictable, with fairly stable growth from year to year. The opposite of inflation is deflation, and it generally only happens during recessions—which are periods of economic decline.  

Monthly changes in the CPI between 2001 and 2021

Chart shows the changes of the consumer price index over

Inflation’s effect on your retirement savings

The investments in your retirement account aren’t adjusted for inflation. This means that, over time, inflation actually reduces your 401(k)’s investment returns. How? In February 2021, annual inflation was at 1.7% for all goods.4 If you had an investment that earned 2% over the same time period, you’d really only have a net gain of 0.3% in your purchasing power because inflation ate away at your overall gains. 

Your 401(k) investments and inflation

Some investments provide better inflation protection than others. Since 1990 (and over the long term), both U.S. stocks and long-term bonds have outpaced inflation.5

The reason that stocks tend to return more than inflation over the long term is that they give you a stake in businesses that can raise prices as inflation goes up. (Also, companies own real assets, such as factories and offices, and their value tends to go up with inflation.) Bonds, on the other hand, may lose money if inflation rises and interest rates go up because their payments are fixed—although these have also tended to grow more than inflation over the long run. 

The return on money market funds should move in line with inflation, but it sometimes lags, causing them to lose purchasing power. So, to help your retirement savings stay ahead of inflation, consider a diversified investment strategy—using a mix helps keep you from being too dependent on the performance of any single investment.

Make outperforming inflation part of your 401(k) investment and saving strategy

As you’ve likely noticed, the cost of living tends to rise over time. Even mild inflation that you barely notice from year to year can take a toll over the long term. To help ensure that you can enjoy the standard of living that you expect in retirement, you’ll need to plan for inflation. So, make sure you’re considering the effect of potential long-term inflation as you’re thinking about your retirement savings and investment strategy.

 

For complete information about a particular investment option, please read the fund prospectus. You should carefully consider the objectives, risks, charges and expenses before investing. The prospectus contains this and other important information about the investment option and investment company.  Please read the prospectus carefully before you invest or send money. Prospectus may only be available in English.

There is no guarantee that any investment strategy will achieve its objectives.

Past performance does not guarantee future results.

The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

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