The Unseen Risk for High-Net Worth Investors: Inflation

Having a high net worth does not necessarily mean you can relax. While you may enjoy the finer things in life, these finer things are becoming costlier over time. Here's what you need to know and how to plan accordingly.

The Unseen Risk for High-Net Worth Investors: Inflation

By Anna B. Wroblewska.

Investing isn't without its worries for high net worth investors. While having a strong asset base is a great thing, managing it can come with a whole new set of stresses -- especially if, like most people, you want to provide the best that you can for your family and your retirement.

One issue that often flies under the radar of even vigilant investors' attention is inflation. You might be laughing -- after all, the consumer price index has barely ticked above zero in the last year! -- but at the end of the day inflation is a major factor for long term portfolios, and high net worth investors face a few key challenges in planning for it.

Luxury goods, education, and healthcare all face higher inflation rates than the overall consumer basket. Here's what you need to know and how to plan accordingly.

Luxury goods

While not all high net worth investors enjoy the finer things, you might be one of the many who do. Unfortunately, these finer things are becoming rich indeed.

The Forbes Cost of Living Extremely Well Index has grown at a rate exceeding inflation by 2.5% per year, on average, since 1982. Some of the items (private jets) are little outside the budgets of all but the wealthiest, but many others, like great tickets to the Met Opera, a nice handbag, or a VIP stay at the hospital, might very well be on your shopping list.

If you consume any luxury goods on a regular basis -- and anything from designer shoes to a nice vacation would qualify -- you need to be aware that the costs of those goods and experiences are rising fast.

A great education

Many high net worth investors want to use their wealth to benefit their children and grandchildren, and that often includes the cost of a great education. Unfortunately, education is also becoming more of a luxury good: in 2014, tuition at private universities rose over 3.5%.

It's part of a longer term trend. To get an idea of just how dramatic tuition increases have been in the last decades, consider this: today, Harvard's undergraduate tuition and fees add up to $45,000. If these costs had risen alongside the overall inflation rate since 1971, this year's undergraduates would be facing a tuition bill of just over $15,000.

Put simply, if you want to provide the kind of educational freedom you dream about for your kids and grandkids, then, you would be wise to build a higher inflation rate into your assumptions about what you'll need to give.

Quality and comprehensive healthcare

Even the wealthy are not immune to rising health care costs. While you may have the peace of mind that comes with knowing you'll manage if the worst should happen, you're still probably trying to grapple with planning for the long term. Can you enjoy a comfortable retirement without worrying about the possibility of a sudden healthcare crisis down the line?

In the past year, healthcare costs have risen almost 2.5% overall, and in the past few years the number has even topped 4%. It's a trend that is unlikely to reverse: a study by the Centers for Medicare and Medicaid estimates that costs are likely to rise by an average of nearly 6% per year for the coming decade.

Even if you're in good health, medical bills are simply a reality at some point. Not only do they need to be included in your projections, but their uniquely high inflation rate needs to be taken into account as well.

What to do about it

Okay, so you're ready to account for inflation. What do you do?

To get ahead of the issue, start by building inflation into your long-term portfolio planning. Instead of using the Consumer Price Index as your benchmark, use a rate that's more commensurate with your actual expenses and priorities. Then, be sure to measure your performance against the inflationary pressures you're experiencing. While you don't necessarily want to pursue high-risk investments to "make up" for inflation, it will help you to be realistic about how well you're doing from a long-term perspective.

On that front, be realistic about the potential need to tap into your principal more than you anticipated. You'll need to budget for larger income withdrawals over time regardless of where the overall inflation rate or the market is. Add healthcare costs or tuition to the equation and you might need even more access to capital and flexibility about your withdrawal parameters.

You might also want to think about what you'll need to do to protect certain chunks of your portfolio for those additional priorities. While it's impossible to know how much your grandchild's tuition will run or whether you'll be shelling out for long term care one day, you can reduce your risk by taking today's costs and projecting accordingly. Run the numbers based on current inflation rates for the time period you have in mind, and compare these to your other expectations about lifestyle and living expenses. Do you need to reassess your lifestyle or budget?

The exercise might bring up more questions than solid answers, but it will set you on a path of prioritizing for the long haul with projections more suited to your situation. After all, at the end of the day, protecting your wealth so that you can meet your family's needs and priorities is what true investment is all about.