How your retirement portfolio could be wrecked by inflation, and what to do about it

I remember hearing a tale once about a gent buying a round of drinks for all the folks in his local bar. "I retired today at the age of 60, and I don't have to work another day in my life," he said, overjoyed at the prospect of a long and happy retirement.

Then some sourpuss spoiled the fun. "You can afford drinks now, but how much money do you really have and how well off will you be if you live for another 20 or 30 years and watch the value of your cash being eroded by inflation?"

With life expectancy increasing, most folks retiring in their 60s these days should easily last until their 80s, and often beyond. But will their cash survive that long too?

A potential killer blow

UK inflation has been around 2% for a few years, but the crashing value of the pound has so far pushed that up to nearly 3% and it could well go higher.

If we continue to see prices rising at 3% per year, in 20 years time every £100 you have today will be worth £54 -- and in 30 years it will have dropped to just £40. How would you cope today if prices of everything suddenly doubled and you still only had the same amount of cash at your disposal?

You might think 3% inflation unlikely in the long term -- but over the past 10 years it's averaged 2.8% And even at a steady 2%, every £100 you have now would be worth only £67 in 20 years, and just £55 in 30 years.

What should you do?

You'll be getting interest on your money, so you'll be a bit better off. But even if you can live on the interest alone and not touch your capital, that's really not enough. What you need is to cover your costs of living from your investment income, and grow your capital in line with inflation so that your future income retains its real value.

The surest way I know to do that is to invest in high-yielding shares, but more importantly shares in companies with a progressive dividend policy -- committed to growing dividends at least in line with inflation.

Moss Bros Group is one example I looked at recently, after it lifted its 2017 dividend by 6.1% while reinforcing its progressive dividend policy. That's way ahead of inflation, so you could take some inflation-adjusted income and keep the rest to reinvest. Oh, and it provided a very nice 6% yield -- and the share price has nearly doubled in 10 years, so you'd be preserving your capital too.

Another example is property investor CLS Holdings, which recently switched away from repurchasing its own shares and to a progressive dividend policy. The latest yield was only 2.6%, but over your retirement decades it's long-term rises that matter -- and hikes forecast for the next couple of years are well above inflation and should yield 3.2% by 2018.

Look for cash cows

Other good retirement investments, in my view, are those that generate oodles of cash, have modest capital expenditure requirements, and can pay most of their earnings out as dividends -- insurer Direct Line with its big special dividends springs to mind.

If you can put together a portfolio yielding 4% or 5% per year in dividends, focused mainly on companies with strong cash flow and progressive dividend policies... well, I think that's the best way to head into retirement.

Wealthy retirement

I reckon a portfolio of shares that combine dividends with capital preservation is ideal for a comfortable retirement, and the Fool's 5 Shares To Retire On guide uncovers some great candidates that provide exactly that.

It highlights a nice mix of shares that have rewarded investors for decades, through both dividend income and share price growth, and which should continue to do the same for many more years to come.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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