With inflation at its highest level in four decades, many investors are trying to figure out how to protect their retirement savings. But figuring out exactly how to hedge your portfolio against inflation is no easy task.
The need to ward off the threat of inflation comes from the fact that rising prices generally reduce the purchasing power of assets. For people on fixed incomes in retirement, inflation means their retirement money might not go as far.
Options for fighting inflation include adding inflation-protected bonds to your holdings. Another approach is to defer claiming Social Security, in order to obtain a larger inflation-adjusted retirement income.
There are also other investment options, but some are expensive. Others are volatile and have had inconsistent performance during past periods of inflation.
“There’s no right answer,” said William Bernstein, an independent financial adviser based in Eastford, Connecticut.
There are pros and cons to almost every option. Here’s what to consider.
A simple way to increase inflation-protected retirement income is to delay claiming Social Security benefits. Retirees would then need to spend more of their investment portfolios to support themselves, but with the S&P 500 up 76% including dividends since March 31, 2020, it’s not a bad time to sell stocks. stocks, said Christine Benz, director of personal finance. at Morningstar,
Retirees can start these benefits anytime between age 62 and 70, but for each month they are late, the payment increases. Benefits are also adjusted annually to reflect increases in the Labor Department’s CPI-W, a measure of inflation affecting blue-collar workers.
For example, someone born after January 1, 1960, who is entitled to $2,025 per month at age 62, would receive $3,587 before cost-of-living adjustments by delaying their claim until age 70. With a 5% adjustment for inflation, the benefit available at age 70 would be about $5,300, according to Bill Reichenstein, head of research at SocialSecuritySolutions.com, which sells Social Security claim advice.
Cost of living increases begin at age 62, whether you claim or delay, and continue for as long as you live. Based on the rise in inflation in the third quarter, the increase for 2022 was 5.9%, the largest since 1982, according to data from the Social Security Administration.
Still, not everyone should delay Social Security. A person who defers their benefits until age 70 instead of 62 would have to live to be 80-and-a-half to come out on top, Dr. Reichenstein said.
When it comes to investments that aim to keep pace with inflation, “I bonds are the best of all,” Bernstein said.
Investors in these US inflation-protected savings bonds are guaranteed to recover their principal plus inflation over 30 years.
They offer a fixed rate for up to 30 years, plus an inflation rate that adjusts semi-annually and tracks the Department of Labour’s CPI-U, a measure of urban inflation.
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You can buy them directly from the US government at TreasuryDirect.gov.
Today, the yield on a standard US 30-year Treasury note is 2.24%. The annualized initial yield of the I bonds is 7.12%. With its currently zero fixed rate, I bonds do not beat inflation. But because conventional Treasury bond yields are now negative when inflation is taken into account, I bonds have a clear advantage, said Mark Iwry, a nonresident senior fellow at the Brookings Institution who has overseen national pension policy. in the US Treasury Department during the Clinton and Obama years.
A disadvantage of I bonds is that each investor can only buy up to $10,000 per year. An investor can buy up to an additional $5,000 if they choose to receive their federal income tax refund in I bonds, Iwry said.
Holders of I bonds cannot cash them in for the first 12 months and lose three months’ interest if they redeem them within the first five years.
When inflation exceeds expectations, ordinary bond prices typically get hammered. This is when Treasury Inflation-Protected Securities, or TIPS, tend to do well.
Backed by the US government, TIPS are bonds with principal and coupon payments that adjust to keep pace with the consumer price index.
The bond market currently expects inflation to average around 2.46% over the next decade. It is the difference between the inflation-adjusted yield of minus 0.51% on 10-year TIPS and the nominal yield of 1.95% on a 10-year ordinary Treasury note. If the CPI averages above 2.46% during this period, TIPS will offer a higher total return than Treasury bills. If inflation is below 2.46%, the classic Treasury will outperform.
With negative TIPS yields today, buyers would lose money on the bonds they hold to maturity. That makes TIPS “a very expensive method of inflation insurance,” said Campbell Harvey, a professor at Duke University’s Fuqua School of Business.
Last year, TIPS returned nearly 6% as inflation surged, according to Vanguard Group.
This year, however, rising interest rates are creating problems for bond prices, which presents another risk factor for TIPS. Even if inflation rises, a sharp drop in bond prices would also hurt TIPS.
You can buy TIPS through TreasuryDirect.gov, brokers or TIPS funds. Morningstar’s Benz suggests putting 10-20% of your fixed income portfolio in TIPS.
Equities and Commodities
In a 2021 study, Professor Harvey and four co-authors looked at eight periods over the past century when US inflation was 5% or higher for at least six months and found that the adjusted return of the equity inflation averaged minus 7% annualized. .
Based on his research, Professor Harvey suggests shifting money from underperforming sectors during inflation, including consumer discretionary stocks such as automakers, to energy and natural resources stocks. who tend to fare better.
The study’s historical data suggests that real estate investment trusts, or REITs, could do well, as landlords have often been able to raise rents in the past to keep pace with inflation.
Commodities are another potential asset, as the prices of metals, oil and agricultural products “tend to hold their value or even outperform during inflationary surges”, Professor Harvey said.
Investors usually buy them through funds that buy commodity futures.
Because commodities can have large swings in performance, Amy Arnott, portfolio strategist at Morningstar, recommends capping exposure to 3% or less of a portfolio. With prices soaring this year, investors risk buying “at a high point in the cycle”, she added.
What about gold? It has tracked inflation, but only over very long periods, like the last century, Professor Harvey said. Over the shorter time horizons investors face, it has been unreliable due to its high volatility, he said.
Write to Anne Tergesen at [email protected]
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