Sorry Social Security recipients, but your COLA increases aren’t cutting it

Current and future retirees probably already know that Social Security retirement benefits are increased each year in step with the nation’s official inflation rate. What you may not recognize, however, is that these cost-of-living adjustments (COLAs) don’t actually keep pace with the ever-increasing cost of living for seniors.

That’s the word from the Elder League, anyway. In its latest report on the topic, the organization concludes that Social Security’s COLA has tracked real inflation in eight of the past 15 years. As a result, the average retiree’s current monthly benefit is about $370 lower than it should be mathematically.

Put another way, seniors have lost about 20 percent of the purchasing power of their Social Security checks since 2010.

OK, it’s not as blatant as it seems on the surface. The Social Security COLA has technically outstripped inflation in five of those years and matched it at least twice. In fact, most of the shortfalls can be attributed to just two years — 2010 and 2011 — due to a quirk in how those increases are calculated.

However, these deficiencies have a cumulative ripple effect. Making them even more problematic is the fact that medical costs have risen more than most other types of expenses, disproportionately impacting older Americans, who typically need more health care.

So what are people to do?

Don’t let inadequate COLAs drag you down in retirement

Fair or not, retired Americans cannot simply ignore the damaged purchasing power of Social Security benefits. They will have to compensate for this headwind themselves, using investments capable of generating income that at least keeps pace with inflation, but also protects capital.

One way to achieve this goal is by holding inflation-protected Treasuries, or TIPS. These are bonds issued by the federal government that pay interest at rates that are adjusted regularly to reflect changes in the Bureau of Labor Statistics’ Consumer Price Index (which is used as the basis for the inflation rate data you hear updated in every month).

The strategy may work, but it’s been less than ideal lately. Interest rates on five-year TIPS yields have been quite low over the past 20 years, and at times even negative. Yields on 30-year inflation-protected Treasuries have not been above 2.55% over the same time frame and currently stand at just 2%. The market prices of these bonds also change as a means of adjusting effective interest rates.

While TIPS holders’ net returns generally balance out over time, even if short in a given year, they can often feel out of step with inflation. They are, but it’s not a huge amount, even in the long run.

You can hold these individual government bonds, although it might be easier to simply hold a basket of them in the form of an exchange-traded fund. The iShares TIPS Bond ETF (ADVICE -0.04%) it fits.

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Conventional versions of these debt instruments may look more attractive to you. The average yield on a 10-year Treasury is currently 3.9%, while investment-grade corporate bonds pay around (a taxable) 5% .

However, returns on these instruments have not kept pace with rising inflation since 2022, and there’s no guarantee that you’ll be able to lock in healthy returns when you’re ready and willing to put your cash to work in this way. Furthermore, there is no inflation adjustment built into these bonds. All you get is the interest payment and the principal back at maturity. They will probably make up for the COLA drop though.

As was the case with inflation-protected Treasuries, an ETF that reflects both bond categories will likely make the most sense for most investors. The iShares 20+ Year Treasury Bond ETF (TLT 0.35%) and the Vanguard Medium-Term Corporate Bond ETF (VCIT 0.26%)respectively, are both cost-effective options.

That said, perhaps your best shot at beating inflation in retirement requires a little more risk than you might have planned to take at this stage in life. These are stocks, or more precisely, stocks that pay dividends.

Dividend stocks may be needed even in retirement

It’s probably not the news some investors were hoping to hear. But it’s still true – stocks remain the most plausible way to at least keep up with inflation over the long term. You just have to accept that there may be short-term bearish volatility that you’ll need to ride out in the meantime.

There are a few ways to make this strategy work for you in retirement. One of them is owning dividend stocks with a strong track record of dividend growth. Dividend Kings has increased its annual dividend payments for 50 years or more. As before, an exchange-traded fund such as ProShares S&P 500 Dividend Aristocrats® ETF (NOBLE 0.38%) will do the job well because it focuses on stocks that have achieved a slightly less than stellar 25-year streak of increasing dividend payments. (The term Dividend Aristocrats® is a registered trademark of Standard & Poor’s Financial Services LLC.)

You know that the dividend yield for the ProShares fund or the typical Dividend King stock is not huge. The ETF’s current yield is just 2.4%. However, its dividend growth has certainly outpaced inflation, improving at an average annual rate of more than 10% over the past decade.

Or you could go the other way. That means opting for a higher yield now in exchange for what could be relatively less impressive dividend growth in the future. take SPDR Portfolio S&P 500 High Dividend ETF (SPYD 0.44%) as an example. Its dividend growth record is respectable, if not thrilling. With a final yield of 4.4%, however, you’d start with a higher, inflation-beating yield.

Distinguish between risk and volatility

But what about the risk of owning stocks (or even baskets of stocks)? It’s there, to be sure. However, don’t confuse risk with mere volatility. The companies behind the aforementioned stock ETFs are blue chips. They’ll take the occasional cyclical bump, but eventually they’ll bounce back and move to even higher heights. It just takes patience.

Or, perhaps the smartest move for you is to own some of all four of these exchange-traded funds mentioned above as a way to ride out the impact of inflation that Social Security doesn’t fully cover. Diversification is rarely a bad thing because it reduces your overall risk and protects you from volatility.