Sorry, Social Security Recipients, but Your COLA Increases Just Aren't Cutting It

Current and future retirees probably already know that Social Security's retirement benefits are raised every year in step with the nation's official inflation rate. What you may not recognize, however, is that these cost-of-living adjustments (COLA) aren't actually keeping up with seniors' ever-rising living costs.

That's the word from the Senior Citizens League, anyway. In its most recent report on the matter, the organization concludes that Social Security's COLA has trailed actual inflation in eight of the past 15 years. As a result, the average retiree's current monthly benefit is roughly $370 less than what it mathematically should be.

Said another way, seniors have lost roughly 20% of their Social Security checks' buying power since 2010.

OK, it's not quite as egregious as it seems on the surface. Social Security's COLA technically topped inflation in five of those years and at least matched it twice. In fact, most of the shortcomings can be attributed to just two years -- 2010 and 2011 -- thanks to a quirk in the way these increases are calculated.

Still, these shortfalls have a cumulative ripple effect. Making them even more problematic is the fact that medical costs soared more than most other kinds of expenses, disproportionally impacting older Americans, who typically require more healthcare.

So what are people to do?

Don't let inadequate COLAs chip away at your retirement

Fair or not, retired Americans can't simply ignore their Social Security benefits' deteriorating buying power. They'll have to offset this headwind on their own, using investments capable of generating income that at least keeps up with inflation but also protects capital.

One way of achieving this goal is by owning Treasury Inflation-Protected Securities, or TIPS. These are bonds issued by the federal government paying interest at rates that are regularly adjusted to mirror changes in the Bureau of Labor Statistics' Consumer Price Index (which is used as the basis for the inflation rate data you hear updated every month).

The strategy can work but has been less than ideal lately. Interest rates on five-year TIPS yields have been quite low over the past 20 years and have at times even been negative. Yields on 30-year Treasury Inflation-Protected Securities haven't been above 2.55% for the same time frame, and currently stand at only 2%. These bonds' market prices also change as a means of adjusting their effective interest rates.

Although TIPS holders' net returns generally balance out in time even if they come up short in one particular year, it can often feel like they're not quite keeping up with inflation. They are, but it's not by a huge amount, even over the long run.

You can own these individual government-issued bonds, although it might be easier to simply own a basket of them in the form of an exchange-traded fund. The iShares TIPS Bond ETF (NYSEMKT: TIP) fits the bill.

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Conventional versions of these debt instruments might look more attractive to you. The average yield on a 10-year Treasury currently stands at 3.9%, while investment-grade corporate bonds are paying on the order of (a taxable) 5%.

Yet yields on these instruments didn't quite keep up with 2022's soaring inflation, and there's no assurance you'll be able to lock in healthy yields at the time you're ready and willing to put your cash to work in this way. Moreover, there's no adjustment for inflation built into these bonds. All you get is the interest payment and your principal back at maturity. Still, they'll likely offset falling COLAs .

As was the case with the Treasury Inflation-Protected Securities, an ETF reflecting both categories of bonds will probably make the most sense for most investors. The iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) and the Vanguard Intermediate-Term Corporate Bond ETF (NASDAQ: VCIT) , respectively, are both cost-effective options.

That being said, perhaps your best shot at outpacing inflation in retirement requires a little more risk than you may have been planning on taking at this stage of your life. That's stocks, or more specifically, dividend-paying stocks .

Dividend stocks are likely to be necessary even in retirement

It's probably not the news some investors were hoping to hear. But it's true all the same -- stocks remain the most plausible path to at least keeping up with inflation in the long run. You just have to accept there may be short-term bearish volatility that you'll need to ride out in the meantime.

There are a couple of ways of making this strategy work for you in retirement. One of them is owning dividend stocks with a strong track record of dividend growth. Dividend Kings have raised their annual dividend payments for 50 or more years. As before, an exchange-traded fund like the ProShares S&P 500 Dividend Aristocrats® ETF (NYSEMKT: NOBL) will do the job nicely, as it focuses on stocks that have achieved a slightly less lofty 25-year streak of rising dividend payments. ( The term Dividend Aristocrats® is a registered trademark of Standard & Poor's Financial Services LLC. )

Do know the dividend yield for the ProShares fund or the typical Dividend King stock isn't huge. The ETF's current yield is only a modest 2.4%. Its dividend growth has most certainly outpaced inflation, however, improving at an average annual pace of more than 10% over the course of the past decade.

Or, you could go in the other direction. That's opting for a higher yield now in exchange for what might be relatively less impressive dividend growth in the future. Take the SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD) as an example. Its dividend growth track record is respectable, even if not thrilling. With a trailing yield of 4.4%, however, you'd be starting out with a bigger 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. Don't confuse risk with mere volatility , though. The companies behind the aforementioned equity ETFs are blue chips. They'll take their occasional cyclical lumps, but they'll also eventually bounce back and move to even higher highs. It just requires patience.

Or, perhaps the smartest move for you is owning a piece of all four of these aforementioned exchange-traded funds as a way of overcoming the impact of inflation that Social Security isn't fully covering. Diversification is rarely a bad thing in that it reduces your overall risk as well as shields you from volatility.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends ProShares Trust-ProShares S&P 500 Dividend Aristocrats ETF. The Motley Fool has a disclosure policy .