Aligning Retirement Saving Goals with Inflation

Pension investors are exposed to the risk of inflation eroding the purchasing power of their savings. Their risk is particularly high due to saving for retirement taking place over many decades. However, few pre-retirement investment strategies incorporate explicit inflation-proofing. It is shown that ignoring inflation is costly in terms of a retiree's welfare, with reductions of up to 25% possible for the average retiree. More risk averse investors face even larger reductions.In a second study, constraints on the amount of pension savings at retirement are imposed. Constraints are used to give the retiree more certainty about the level of pension savings at the date of their retirement. Such constraints may be expressed in either real or nominal terms. However, ignoring inflation by using nominal constraints gives a potential reduction in welfare of up to 36% for the average retiree. The results illustrate that nominal constraints are ineffective at reducing the risk of inflation.The conclusion is that pre-retirees ignore inflation at their peril. It must be included explicitly in retirement savings targets to improve retirement outcomes. Consequently, there should be greater investment in an index-linked bond or a similar asset