A. Inflation rate has been low in recent years, but historically inflation rate averages more than 2%, and compound that with time, it could significantly erode an investor, especially a person who is close to retirement's returns.
Generally there are two ways to ensure your nest egg keeps up with inflation -
1. Invest in Stocks
Over the long time, stocks are the best hedge against inflation, see this chart. Therefore, even for retirees, it's a good idea to keep exposure to stock markets, for example, keep 60% of exposure to stocks when entering into retirement phase.
2. Purchase TIPS
TIPS stands for Treasury Inflation Protected Securities. They are bonds issued by the Treasury Department with the following features: principal will be adjusted for inflation, and you are guaranteed a fixed rate of interest every six months, so as the principal rises, the amount of interest you earn will increase as well.
How to purchase TIPS?
You can buy TIPS directly from the Federal government if you set up a Treasury Direct account, in this way, you don't have to pay a commission to buy them, and you will avoid a management fee that comes with a TIPS fund. Plus, if you invest in TIPS directly, you will never get less than your original investment when the bonds reach maturity.
How to minimize risks of TIPS?
TIPS have risks too, how to minimize its risks? Please see discussion at this blog post.